Do You Have to Claim Settlement Money on Taxes?
When you receive a settlement payment, do you have to claim it on your taxes? The answer to this question will depend on what you were compensated for. While a check for property damage is unlikely to be taxed, lost wages in a personal physical injury case will be. In this situation, you must claim the money on your taxes and pay any applicable income taxes. There are some exceptions to this rule.
Generally speaking, plaintiffs should be aware of the fact that the IRS may be able to tax attorney fees and settlement money. This is an exception if the damages are for physical injuries and do not involve punitive damages. In such a case, a settlement payment that includes attorney fees will be taxed as income. However, if the payment includes other categories, such as emotional distress, you should be able to negotiate for the 1099 income to be reduced.
If you have a large settlement, it is best to speak with a qualified accountant or attorney to understand how your lawsuit settlement will impact your taxes. For example, you may have to pay for your attorney out of the settlement itself, you may have to pay income tax, and you might have liens against your settlement. Regardless of your reason for claiming the settlement, it is still important to understand your tax obligations so you can make informed decisions.
If you have medical bills, you don't have to claim these expenses. The IRS has a rule that says that certain medical expenses are deductible if you itemized them in the prior year. However, if you receive a settlement for emotional distress, you will have to claim these medical expenses as income in the year you receive them. This rule is referred to as the "tax benefit rule."
The IRS will always tax punitive damages, which are a penalty awarded to the defendant. Punitive damages are not typically given in combination with compensatory damages, and are easy to separate from non-taxable items. Interest, however, is paid on the monies gained in lawsuits. Interest begins accruing on the day of the lawsuit and ends on the date the defendant pays the remaining amount. Interest is considered income for accounting purposes.
Generally, settlements for physical injuries or sickness are not tax-deductible, but you will have to deduct some of the costs from your previous years before the settlement was awarded. In addition, any emotional distress damages that resulted from the accident will be taxable. The IRS also considers punitive damages, which are paid to the plaintiff when the injured party causes them to suffer physical harm or emotional distress.
Whether you have to claim your lawsuit settlement money on your taxes depends on the type of lawsuit you filed and what it was for. For instance, physical injury damages are not taxable, but the money from a lawsuit settlement after paying medical expenses are taxable. Therefore, you should consult a tax professional or attorney when determining the exact tax consequences. If you filed for bankruptcy, you can use any settlement money as capital income.