A lawsuit settlement can have tax implications. While the amount is usually not taxable, if you receive a settlement as a result of a lawsuit, you may be liable for taxes on a portion of it. To determine if you're liable for taxes, you must first determine the character of the claim and whether the payment is taxable income or a wage. Then you must figure out what to report and what forms to complete.
The Internal Revenue Service considers the purpose of a settlement when determining whether it is taxable. If the settlement was awarded as a result of a lawsuit, a court may tax a portion of the payment as taxable income. If this is the case, the amount should be reported on a pro rata basis. However, if the settlement was awarded to you as a result of a claim against a company, you may be liable for taxes on a portion of the settlement.
The Internal Revenue Service has made rules regarding the taxation of lawsuit settlements complicated. In general, settlements for physical injury or loss of income will be taxed as income, and may be subject to social security taxes or Medicare taxes. However, settlements for emotional distress may not be taxed, as long as they resulted from an injury. Therefore, it's advisable to consult a tax accountant prior to receiving a settlement.
When determining your tax liability, the IRS will look at the total circumstances. They'll start by examining the language of your settlement judgment, which will help them determine if the settlement is for physical injuries or damages. If you receive a judgment that doesn't match the actual losses and injuries, the IRS may ask more questions. However, you should keep the majority of your settlement. This will protect you from having to pay taxes on an entire amount of it.
Interest earned from a lawsuit is also taxed. In addition to compensatory damages, you can also receive punitive damages. Punitive damages are always taxable. This is because they're awarded as a punishment for the defendant's actions. Punitive damages are not usually awarded in conjunction with compensatory damages. However, they're easy to identify among taxable and non-taxable items. For accounting purposes, interest is considered income.
If the damages include pain and suffering, you'll need to decide how to allocate them between different claims. Physical injuries are non-taxable, while emotional distress is taxable. You can prove this by presenting medical records and declarations from treating doctors or medical experts. Usually, if you can prove that the defendant caused your injuries, you're unlikely to owe any taxes on your settlement.
A taxable settlement can bump you up into a higher tax bracket if it's too large. If you can spread out your settlement payments, you'll be able to reduce the amount of money subject to the highest rates. While taxation is a responsibility for every investor, forecasting your taxes is sometimes tricky. To make things easier, you can use our tax calculator to estimate how much you owe on any given amount.