Legal judgements can have tax implications. Image: Flickr / mrbill / CC-BY-SA
Receiving money from a lawsuit, judgement or settlement can feel like the end of a stressful time. Unless you carefully plan, however, the IRS could take a large chunk of that judgement come tax time.
Which judgements are taxable
The Internal Revenue Service does not consider all legal judgements or payouts taxable. The definition of what is taxable, however, is unsettled despite heavy litigation. Generally, physical injuries or payouts for physical ailments are exempt from tax requirements. This is a specific limitation; the punitive damages or lost wages from a physical injury are considered taxable. Physical symptoms from emotional distress do not count as a non-taxable physical judgement.
How judgement income is taxed
Judgements are not necessarily taxed like income. Any judgements for lost wages may be considered wages and should usually be reported as such on tax forms. Judgements or payouts that are not for a physical injury and are not lost wages should be reported as “other income” on tax forms. If you are not sure where your judgement payout should be categorized, you should consult with a tax lawyer or accountant before you do your taxes.
Settling may save money
If you have the option of settling your case, wording the settlement agreement carefully could save you quite a bit of money on your eventual tax bill. A settlement agreement could outline that the payment is for physical injury or physical ailments associated with a physical event. The IRS is not required to follow the wording of a settlement agreement, but if you have in writing that the settlement is for a physical injury, you have a defensible case. You should always discuss the tax consequences of a possible lawsuit or settlement with your lawyer and an accountant.
Sources
Foreclosure Law Firms
PrairieLaw
IRS
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