If you've recently received a settlement for an injury you've suffered due to someone else's negligence, you might be wondering, "Do I have to pay taxes on this money?" The answer depends on many factors, including the type of lawsuit you're involved in and the exact amount of compensation you received. If you've received compensation for your pain and suffering, you'll most likely be taxed if it's a compensatory award, such as for emotional suffering. However, if you've received a settlement for damages related to emotional distress, such as for medical bills, you may not have to worry about paying taxes on this money.
Some types of settlement money may be taxable. For example, if you won a property damage lawsuit, some of your settlement could be treated as a capital gain, and the money would be taxed at a higher rate. This is especially true if you received a settlement that was so large that it pushed you into a higher tax bracket. However, by spreading the payments over the course of your settlement, you can reduce the amount of your settlement that's subject to the highest tax rate.
Another important distinction between a personal injury lawsuit and a tax-free settlement is the type of damage claims. Most personal injury claims aren't taxable, as long as there is observable bodily harm. Generally, if you received compensation for your pain and suffering due to someone else's negligence, the amount you received is not taxable. If you're awarded a settlement for a property damage lawsuit, the IRS will treat the compensation as ordinary income and tax it accordingly.
If you're receiving a substantial settlement, it's important to discuss all aspects with an accountant or attorney. It may be necessary to pay the attorney out of the settlement money, and you may be subject to liens or income tax. If you don't discuss the details of your settlement with a qualified accountant or attorney, you could end up with an unappealing tax bill in April. The key is to get your legal representation on board from the beginning.
While determining whether you'll have to pay taxes on your lawsuit settlement can be a tricky process, it's worth it. The IRS's rules for taxation are generally quite similar to the rules that govern your regular paycheck. In some cases, it's possible to deduct the amount of taxable income you receive by working with your attorney. There are many other ways to decrease the amount of taxable income.
Personal injury and sickness damages are generally tax-free, but you must report them as income if you use them for medical expenses. The same rule applies to punitive damages, which are awarded to punish the defendant for their harmful behavior. Punitive damages, however, are taxable. The IRS requires that you report them as other income. So, if you receive a punitive award for emotional harm, it will be taxed as normal income.