How to Claim a Settlement As IncomeHow to Claim a Settlement As Income
If you win a lawsuit settlement, it`s essential to understand its tax ramifications. 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 a lawsuit settlement
Both parties can reach an agreement through settlement, saving time and money. This approach can sometimes result in a better outcome as it gives each side more control over the case and substantial compensation payments.
Note, however, that any settlement could be subject to taxes. 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.
IRS also has ruled that emotional distress damages can be tax-free, such as if the actions of your employer worsens your symptoms of multiple sclerosis. A portion of any settlement may even be tax-free.
Non-economic damages
Non-economic damages compensate for losses which cannot be quantified financially. These include lost income, pain and suffering from physical injury, emotional distress, disability or disfigurement, as well as a decreased quality of life.
Damages for personal injuries are determined by jurors; however, most personal injury claims are settled out-of-court.
Non-economic damages are calculated by multiplying a victim`s total economic damages with an appropriate multiplier, with higher multipliers applied in cases involving permanent impairment, catastrophic injuries and other significant damages.
When determining non-economic damages a jury will consider a variety of factors, such as subjective values, beliefs, emotional sensitivity, feelings of injustice, and disruptions to their lives caused by others.
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.
Punitive damages exist to deter defendants from engaging in similar behavior in the future and maintain an equitable civil justice system by discouraging plaintiffs from demanding excessive amounts for minor events.
Attorney fees
In many federal laws that protect consumers against debt collection practices, discrimination in employment, and environmental harms, courts can award attorneys fees to successful plaintiffs.
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. It can make it more challenging for people to assert their rights, as well as deprive them of vital benefits such as Earned Income Tax Credit (EITC).
You must report the settlement as income if you are a plaintiff. Otherwise, taxes could be assessed on all or some of your settlement prior to deducting legal fees; depending on its type, this could also include punitive damages which can lead to an unexpectedly large tax bill.