What Are the Different Kinds of Lawsuit Settlements?
Getting a settlement from a lawsuit could be due to one of a few reasons, such as the following:
- Physical injuries
- Damages from non-physical injuries
- Punitive damages based on the defendant’s conduct
Upon receiving your settlement, hire a tax accountant within the tax year, even if you usually file your taxes independently. The IRS provides rules about the parts of a lawsuit settlement subject to taxes. It would also help to get legal counsel from a skilled lawyer from a civil justice law firm in San Antonio, TX, concerning lawsuit settlements and tax payments.
How Do Taxes on Lawsuit Settlements Work?
In addition to the lawyers’ fees payable after receiving your settlement, there are taxes to deal with. The tax liability for the recipients of lawsuit settlements depends on the type of settlement involved. Generally, damages from a physical injury lawsuit are not taxable income.
However, if the settlement amount excludes your medical expenses, the remaining amount will be taxable because you can’t receive the same tax break twice. Sometimes, you can get damages for a physical injury arising from a non-physical lawsuit. For example, you could win damages for stress-induced headaches after being libeled. These damages are not taxable.
Emotional distress damages are taxable. However, if the damages are due to a physical injury or manifest in physical symptoms for which you seek treatment, you’re not required to pay tax. Note that you owe taxes on the total amount you receive, including the attorney fees. Consult a San Antonio personal injury lawyer if you need clarification on the tax payable on your settlement amount.
What is the Federal “Actual Damages” Rule for Settlement Taxes?
Under the Internal Revenue Code, most of your income from a settlement or court awards should not be taxed. You will not have to pay taxes on damages awarded for the following:
- Lost quality of life
- Lost ability to enjoy spousal companionship or loss of consortium
- Home renovations to improve accessibility
- Hospital or clinic bills
- Pain and suffering
- Physical therapy and rehabilitation
While these types of compensation incomes are non-taxable, they must be directly related to the physical injuries you sustained in an accident. These are referred to as “actual damages.” An experienced San Antonio personal injury attorney can evaluate the damages and help you evaluate the taxable damages.
What Factors Affect a Lawsuit Settlement?
All payments from any source are considered gross income unless they have an exemption. It can be complex to determine if your settlement award is taxable without the help of a skilled lawyer. Your lawyer can help you analyze the following, which are the most common factors that determine the taxability of your settlement income:
Lost Wages and Federal Taxes
The “actual damages” rule applies to the damages you receive for lost damages. As long as your compensation relates directly to the physical injuries you sustained, it will not be subjected to taxes.
That means that the claim related to the personal injury claim is not taxable if you won two lost wages awards in the same trial. The one related to your wrongful termination claim will be subject to Social Security and Medicare taxes.
Punitive Damages and Federal Taxes
The jury may award you punitive damages and the claimed losses upon winning your personal injury case at trial. These damages aim to punish the offender and warn others not to commit the same negligent behavior that caused the accident that led to your injuries.
Punitive damages are largely unrelated to your physical injuries and don’t qualify as “actual damages.” Since you don’t claim punitive damages, but the court grants them, they are subject to taxes.
Interest and Federal Settlement Taxes
The insurance company may not pay out immediately if you secure a settlement or compensation for your injuries after an accident. If that happens, the insurer will owe you interest on the original award. The interest accrued on your settlement amount before a payout is taxable, like the interest you earn on your loan to someone, a Certificate of Deposit (CD), or a savings account.
Awards won for medical expenses are taxable if you didn’t deduct related medical bills during the previous tax year. If you deducted them, you’d pay taxes on the amount you receive under the IRS “tax benefit rule.”
If you receive a non-taxable settlement, the legal fees you owe won’t affect the taxable income. Accident and personal injury cases are excluded, including slip and fall or worker’s compensation. However, if you receive a taxable settlement, you may owe taxes on the full payment, even if the attorney fees are paid directly to your San Antonio personal injury lawyer.
Capital Gains Instead of Ordinary Income
Depending on the type of claim and the settlement, you can treat a portion of the award as capital gains. For example, damages awarded in relation to your home or factory may be classified as capital gains. Alternatively, the award can be classified as a recovery of tax basis, which doesn’t count as income.
An Experienced Personal Injury Attorney Helping You File Taxes on Your Settlement
Receiving a settlement for the injuries you sustain due to another person’s negligence can be a life-changing step in addressing a crisis. However, before you pay for any expenses out of the settlement, remember to account for taxes. That depends on the type of settlement you receive.
A skilled personal injury lawyer in San Antonio can evaluate the type of compensation and guide you on taxes payable. Our civil justice law firm in San Antonio has been providing legal representation for clients in personal injury cases for many years, helping them win the award they rightfully deserve. Contact us for a FREE case assessment.