A common question - are lawsuits taxable? - arises from the fact that some types of damages are taxable, while others aren't. For example, damages for emotional distress and back pay are usually taxable. However, there are exceptions. Attorney fees paid by both sides of a lawsuit are generally not tax deductible. However, the fee paid by the plaintiff's attorney may be deductible depending on the type of lawsuit.
The answer depends on the nature of the settlement. In many cases, settlements are taxable because they typically include a number of issues and multiple courses of conduct. As a result, each type of compensation may have different tax treatment. When this happens, the parties involved may agree to allocate a portion of the total damages to different categories. Although such allocations are not legally binding, they are still worth considering. If you are sued for property damage, for example, the settlement may be taxable.
Emotional distress claims can add an extra wrinkle to your taxes. Fortunately, most emotional distress settlements aren't taxable, unless they are related to physical injuries. For example, a car accident might result in severe depression and emotional distress for the plaintiff. If the settlement was intended to compensate for these feelings, the money received would be taxable. Therefore, if you want to make your settlement taxable, you should consult a professional accountant to determine how much money you can expect to receive.
Although most lawsuit settlements are taxable, they may still be deductible for the plaintiff. In general, you can deduct the cost of your attorney's services if you are able to prove that the plaintiff caused the damages. However, if the settlement is for a substantial amount of money, you might want to discuss your tax situation with your attorney before accepting a settlement. The new law also disallows deductions for certain types of legal fees and settlements, including those for personal injury cases without punitive damages.
The IRS does not tax physical injury and sickness settlements, but emotional distress compensations are. However, you may also qualify for a taxable amount if you win a lawsuit for emotional distress. Punitive damages, meanwhile, are taxable. However, they can provide substantial payouts to plaintiffs. As long as they are paid in the context of a lawsuit, they are not considered taxable. If you choose to file your taxes based on the amount of your settlement, you can deduct a portion of it.
Depending on the type of lawsuit and the origin of the claim, the taxation of legal settlements varies. For example, a wrongful termination award will be taxed as wages and emotional damages, while a settlement for contractor negligence may not be taxable as income and treated as a reduction of the purchase price of a real asset. However, the IRS and courts rarely consider these agreements unless the plaintiffs and defendants have agreed upon them.