Many settlement winners do not know that they will be taxed on the settlement. Tax costs have recently increased thanks to the new tax reform law. Plaintiffs may be taxed on attorney fees too if the attorney receives part of the settlement amount. Settlement taxes are often hefty, unforeseen expenses.
What you need to know about settlement taxes:
- The nature of the claim determines the type of tax. For example, if you sue seeking wages, your settlement will be taxed as wages earned.
- Physical injury settlements are tax–free.If you sue for physical injury or illness, damages are tax-free. Any illness that can not be physically proven is subject to taxation.
- Appropriating damages can reduce taxes.Because most disputes involve multiple issues, it may be best for the plaintiff and defendant to agree on how they will handle taxes.
- Attorney fees are included in taxes.The full settlement you receive will be taxed as income even if you use a contingent fee lawyer.
- Punitive damages and interest are taxable. Even if you receive a tax-free settlement, pre-judgment and post-judgment interests are always taxable. Punitive damages are also always taxable.
It is best to plan ahead. Speaking with a tax attorney before you settle may help reduce the amount of tax you will have to pay. If you don’t realize that you will have to pay tax until you get your IRS Forms 1099, you may be in trouble. Coming up with large sums of money is never easy.