How to Claim a Settlement As Income
It`s important to know the tax implications of a settlement if you are awarded one. This topic can have many nuances. Working with an accountant and attorney who are experienced in this area can help you identify which parts of the settlement may be tax free and which require payment.
Taxes on the settlement of a lawsuit
Both parties can reach an agreement through settlement, saving time and money. Sometimes this approach results in better outcomes as it gives both sides more control of the case as well as substantial compensation payments for both.
Be aware that any settlement may be subject to tax. Tax planning can help you reduce your taxable income before receiving settlement money. This will give you peace of mind in the years to come.
Tax exempt damages such as medical expenses should be discussed during settlement negotiations to avoid potential surprises in terms of taxation.
The IRS has also ruled that certain emotional distress damages are tax-exempt, for example if your employer`s actions worsen your multiple sclerosis symptoms; part of any settlement could be considered tax-free.
Non-economic damages
Non-economic damages provide compensation for losses that cannot be measured financially, such as lost income, physical pain and suffering, emotional distress, disfigurement or disability, as well as decreased enjoyment of life.
Damages for personal injuries are determined by jurors; however, most personal injury claims are settled out-of-court.
The non-economic damages are determined by multiplying the victim`s economic damages by an appropriate multiplier. Higher multipliers will be applied to cases that involve permanent impairment, catastrophic injury, and other significant damages.
A jury must take a number of factors into consideration when awarding non-economic damages, including subjective values and beliefs as well as emotional sensitivities, feelings of justice and the disruption in their life caused by another.
Punitive damages
If your case involves a defendant who committed acts of oppression, fraud, or malice against you, punitive damages may be available as legal compensation from a judge or jury in addition to compensatory damages to make an example out of them.
Most states limit punitive damages to four times what was awarded in compensatory damages.
The purpose of punitive damages is to discourage defendants from repeating the same behavior and to maintain an equitable system of civil justice by preventing plaintiffs from demanding excessive sums for minor events.
Attorney Fees
Numerous federal laws, such as those protecting consumers from debt collection practices, employment discrimination and environmental harm, permit courts to award attorney fees to winning plaintiffs in court cases.
These awards are not deductible under current tax laws, as they are considered income to both the plaintiff and the attorney.
The new tax law undermines consumer protections in this way. The new tax law can make it harder for consumers to assert their rights and deny them vital benefits like the Earned Income Tax Credit.
You must report the settlement as income if you are a plaintiff. If you don`t, the IRS could assess taxes on your entire settlement before deducting legal costs.