In general, lawsuit settlements may be taxable income.
However, the taxability of your lawsuit settlement depends on the nature of the underlying claim or lawsuit, as well as the specific terms of the settlement agreement.
To answer the question, “Are lawsuit winnings taxable?” we will need to carefully examine the facts of the case at hand. Read on to find out more.
What Parts of Lawsuit Settlements Does the Government Consider Taxable?
Are lawsuit settlements taxable income? This question often pops up when people start thinking about the ramifications of receiving a monetary settlement.
Typically, taxable proceeds from a lawsuit settlement may include the following:
- Lost wages or salary – If the settlement includes compensation for lost wages or salary, this amount is generally taxable.
- Interest and punitive damages – Interest earned on the settlement amount and punitive damages awarded as a result of the lawsuit are also considered taxable income.
- Emotional distress or mental anguish – Settlements for emotional distress or mental anguish are generally taxable unless the distress or anguish resulted from a physical injury or illness.
- Attorney fees – If the settlement includes compensation for attorney fees, this amount is generally considered taxable income to the plaintiff.
If the settlement includes both taxable and non-taxable amounts, you may need to allocate the settlement between these two categories.
A tax professional or tax attorney can help you determine the specific tax implications of a lawsuit settlement.
When Are Lawsuit Settlements Not Taxable Income?
As we mentioned, not all parts of a lawsuit award or settlement are taxable. Typically, direct damages may not be taxable as income.
Some examples of non-taxable settlement allocations include the following categories.
Compensation for Physical Injuries or Illness
If the portion of the settlement or total settlement amount is for physical injuries or illness, the amount may not be taxable.
Compensation received for medical expenses, lost wages, and pain and suffering related to the injury or illness is generally not taxable as income.
Reimbursement of Medical Expenses
Reimbursement of medical expenses, including the cost of durable medical equipment, prescriptions, and transport to appointments, is typically not taxable. Be sure to save all receipts.
Settlements for property damage are generally not taxed as income. If your settlement includes funds to repair or replace damaged property, this is usually not taxed.
Gifts or Bequests
If the settlement is a gift or bequest, the amount received is generally not taxable. Be sure to check the laws in your state to confirm.
Child Support or Alimony
Child support is not considered taxable income to the recipient and is not tax deductible by the payer.
This means that if you are receiving child support as part of a settlement, you do not need to include it as income on your tax return.
On the other hand, alimony payments are generally taxable income to the recipient and tax deductible by the payer, unless your divorce was finalized after December 31, 2018.
Be sure to check with your attorney or tax professional to confirm the status of your settlement.
So, are lawsuit settlements taxable? The answer is—as with many things in life—it depends. It is very important to note that these rules can be complex and there may be exceptions.
It is always best to consult with a tax professional or attorney to determine the specific tax implications of a lawsuit award or settlement.
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