With new tax laws coming into place, there has been a lot of speculation over how and when settlements will be taxed. It is important to know just how taxation of lawsuits is handled, so that you do not settle your injury case and end up with a large tax bill at the end.
What is and in Not Taxable
First, as a general rule, settlements or verdicts that compensate you for losses as a result of an injury are not considered taxable. Of course, there are exceptions to everything, and this is no different.
As an initial exception, if you took a tax deduction on something related to your injuries in the past, you will need to pay taxes on the portion of your recovery that represents those damages.
In other words, if you took an exemption or deduction for medical expenses you paid, you can not then keep the part of your settlement that represents the medical expenses, tax free.
Mental distress or mental disability is only deductible if it is caused by or associated with a physical injury, although there are deductions you can take to lessen your tax burden. So, for example, if you were injured at an amusement park and developed a fear of amusement parks for which you needed treatment, any compensation for that would be taxable. Compensation for the anger, fear, upset, or anxiety that you experienced as a result of the accident itself would not be taxable.
Recovery for lost wages may be taxable, and reported and taxed as if they are normal wages paid to you. Wages can present a unique problem—if you are compensated for multiple years of wages all at once, you may end up in a higher tax bracket than you normally would be in if you paid income tax every year.
Punitive damages are almost always taxable.
Avoiding Tax Burdens
Although simply putting language in a settlement that “this amount represents this kind of damage and not that kind” is not completely foolproof, it can help. There may be better ways of avoiding a tax burden—for example, by foregoing a punitive damage claim altogether, or by preserving documentation of your lost wages if they are nominal to show that a small part of your settlement was for wages.
Most settlements and verdicts are paid lump sum, and an attorney will take his or her fee from the money awarded. This is called a contingency fee arrangement.
In injury settlements, because the fees generally represent money to make the victim whole, and thus are not taxable and not reported, you would not pay taxes on the fees that you paid to the attorney; however, you would not get a deduction for paying those attorneys fees, either.
However, in non-injury cases, such as breach of contract, defamation, stockbroker negligence, or intellectual property suits where fees are awarded, the entire settlement is taxable, even if part of that settlement is actually being paid to the attorney.
Make sure that your rights are protected during any trial to recover damages for injuries suffered in an accident. Contact the attorneys of Brassel, Alexander, LLC today for a free consultation to discuss obtaining recovery for injuries you have sustained.