Do you need to pay tax on that large lawsuit settlement?
So you have just been awarded a large cash payout after winning a personal injury claim. We all know that death and taxes are inevitable in this fantastic world we live in.
Not so fast, there are grey areas, and sometimes the law is quite vague, resulting in some loopholes.
Approximately 95% of personal injury lawsuits go to trial – the rest are settled out of court.
Let’s look at the general rules and see whether you need to hand over a large chunk of your settlement to the taxman.
We will also try to answer the question “is a lawsuit settlement taxable?”
Although different states have different rules, we chose the state of Florida to focus on for this article.
What is the general rule?
The general rule is that compensation for physical injury is not taxable. This bars both the IRS and your state from taxing you on the proceeds resulting from a personal injury claim.
Any compensation for loss or damages resulting from personal injury or physical sickness is not taxable. So, attorneys fees, medical bills, lost wages, loss of consortium, and emotional distress are not taxable, provided they were all incurred as a direct result of personal injury or sickness.
This is true whether you received your award in the form of a pre-trial settlement or after a jury verdict.
Exceptions to the general rule
Punitive damages, though rare, are always taxable. These are distinct from compensatory damages. If you have a punitive damages award, your attorney should approach the court to delineate punitive and compensatory amounts. This will avoid later disputes with the IRS.
A notable exception is that any interest earned and awarded will be taxable. In addition, interest added onto the claim by the court to take into account loss of interest during the time the verdict has been pending, is taxable.
Any portion of your award which was made for lost income is taxable. This is important to remember. The IRS does not care who paid you the money. If it was income paid, then it is taxable.
Emotional distress may or may not be taxable. For example, it will not be considered taxable income if you have suffered emotional distress directly from the injury. However, if the distress is not related to the injury, it will be taxed.
If you have a case based on a breach of contract that resulted in an illness or personal injury, then your settlement will be taxable. So it depends on whether your claim is founded on a breach of contract or personal injury, or illness.
Should you have two claims against the defendant and one is a personal injury claim, and one is not based on personal injury, it is critical to demarcate these claims as one is taxable and the other is now.
Wrongful termination awards are taxed as they fall under the lost wages category.
Taxation rules are full of nuances and exceptions. Therefore, this area is best left to a specialized local attorney with an established track record to minimize your tax liability and receive the maximum compensation owed to you.