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Are lawsuit settlements taxable?

Personal injury lawsuits either end up getting settled or go to trial in court. A settlement occurs prior to trial between both plaintiff and defendant and both parties work to come to a monetary dollar amount that will satisfy both parties. A settlement prevents both parties from going to trial. A settlement is usually preferred since a trial could be very costly. Our personal injury attorneys take settlements very seriously and want to make sure that our clients understand what a settlement would mean for them. The structure of the settlement should be understood by the client before accepting the settlement offer. For a free case evaluation, contact us today.

Many plaintiffs are surprised to see that the settlement amounts are taxed after the settlement check comes in the mail. Even if the attorney’s fees are a percentage, the plaintiff will have to be taxed on the entire settlement amount rather than the amount deducted after fees. For example, if the settlement amount was $100,000 and the attorney’s fees were $30,000, the plaintiff would have to pay taxes on the $100,000 rather than the $30,000.

The general rule is that settlement money collected from the defendant is considered income under the IRS. The IRS will then have to tax that income coming in. However, personal injury settlements are an exception to income. For example, a car accident settlement is not taxable.

Whether settlements can be taxable or not taxable depends on the circumstances. Since failing to pay taxes is a federal crime, we suggest you consult with your personal injury attorney after the settlement to determine if taxes should be applied and if so what accountant you should reach out to calculate those taxes.

How long does a settlement take?

A settlement could take from a couple of months to a couple of years depending on the situation. The process to obtain a settlement must be followed thoroughly and correctly in order to be able to seek a settlement amount. The longer it takes to collect evidence, the longer it takes to get a settlement offer. That’s why it is crucial to have a personal injury lawyer in Los Angeles who has extensive experience with your case and will be able to give you an exact estimate. For more information on specific types of slip and fall settlements, please visit our page here.

Which settlement amount is not taxable?

Below is a list of examples where settlement amounts are not taxable depending on the circumstance.

Physical injuries

Settlement amounts for physical injuries are not usually taxable. This is because it is demonstrating “observable bodily harm.”  If the settlement amount is given to compensate the plaintiff for some type of physical injuries sustained as a result of the accident, the IRS will not recover any taxes. The settlement amount will therefore not count as income on the tax form. Since it is not income, it does not have to be taxed. Examples of physical injuries include pain and suffering and emotional distress from physical injuries as a result of the defendant’s negligence.

Medical expenses

Medical expenses that have been reimbursed through settlement amounts are not taxable and do not have to be itemized deductions or income. If the settlement is reimbursement for medical expenses after claiming a deduction, the settlement offer may have to be taxed since the plaintiff took a deduction in the previous years. For more information on this type of medical expense settlement tax deductions, please speak to your personal injury attorney or visit the IRS tax benefit rule form.

Emotional distress

Any settlement money received as a result of enduring emotional distress is not taxable. But, the emotional distress must have been caused by a physical injury that occurred from the accident. If there is no physical injury, then the settlement is most likely taxable under both the state and the IRS. If the foundation of the lawsuit is physical injury-related, then the settlement offer is most likely not taxable.

Property damages

Settlements that repay the loss of value of the property are not taxable. But if the settlement amount is more than the amount it would take to replace the property, then it would be taxable.

What type of settlement offers are taxable?

Punitive damages

Punitive damages are most common in personal injury lawsuits and are those that are meant to make an example out of the defendant. Punitive damages are not mandatory damages and are determined on a case-by-case basis. Punitive damages are taxable and should be reported as income to the IRS. For more information on punitive damages and how they are taxable, please visit our page here. Punitive damages must be reported under other income on line 21 under form 1040.  Specifically, the state of California also taxes punitive damages as a result of settlement offers.

Lost wages

Lost wages collected from a settlement offer is taxable and income tax will be added, especially subject to Social Security taxes and Medicare tax. Since lost wages are meant to compensate plaintiffs for wages they would have made in the previous years, the amount will be taxable. Our attorneys recommend that you consult one of our settlement attorneys for more information on how this could be claimed in the tax forms.

Key takeaways

  1.  The taxes depend on where the claim is originating from. If the claim is originating from any type of physical injury, then it is not likely taxable. If the claim stems from lost wages, then it is taxable.
  2. Emotional distress is taxable if the symptoms are not physical.
  3. Damages should be allocated prior to accepting a settlement offer to figure out how the taxes will be allocated.
  4.  Punitive damages are always taxable.
  5.  Attorney’s fees are not deducted from the taxable amount.
  6. Consult an accountant to determine what type of damage the settlement offer would try to replace.

California taxes

The majority of personal injury settlements in California are not taxable. The state of California does not impose extra taxes on top of what the IRS has already imposed.

Judgment interest taxable?

Judgments made by the court are taxable. Interest on judgments is also taxable and requires that the plaintiff has to state as an income coming in. Another factor of the plaintiff must keep in mind is the tax implication of moving on to a higher tax bracket as a result of the judgment coming in.

Los Angeles settlement attorneys

Contact our Los Angeles settlement attorney for more information on what settlement offers could be taxed. This is a very crucial step since failing to report taxes is a federal crime. Settlement offers and how they are taxed need to be looked at very meticulously. It is also very important to understand what amount will be taxable prior to accepting a settlement offer since it could determine the settlement acceptance.

***Disclaimer: This page is created by Heidari Law Group for educational purposes. This article provides a general understanding of the law. It does not provide specific advice. By using this site and reading through this page, there is no attorney-client relationship created between you and any member of Heidari Law. Further, due to the constant change of the law, some parts of the information above may no longer be good law.