Generally speaking, any settlement or judgment amount you receive as compensation for lost income is subject to income tax. The reasoning is that your original income would have been taxable if you hadn't suffered the loss of income, so any compensation intended to replace that same loss of income should also be taxable. The money you receive as part of an insurance claim or agreement is usually not taxable. The IRS only collects income taxes, which is the money or payment received that results in you having more wealth than before.
Taxes on liquidations can vary widely. The IRS states that money received in a lawsuit should be taxed based on its purpose. If all or part of your agreement was for back wages from a W-2 job, then you won't receive a 1099-MISC for that party. If your case is based entirely on physical injury, for example, from a car accident, your legal agreement will not be taxed at all, no matter what your attorney's fees amount to.
If you have sued for damage to your home or commercial factory, you may be able to classify the settlement as capital gains. Interview the taxpayer to determine if the taxpayer provided any type of settlement payment to any of their employees (past or present). During agreement negotiations, you can negotiate to assign a larger part of the agreement to non-taxable award categories. If lost wages are part of the award or settlement for the physical injury or illness, they are part of the compensatory damages and are not taxed.
If you plan to issue one, negotiate 1099 revenues to be a lower number than your actual settlement amount. You can find all of this information in the IRS Claims, Awards, and Settlements Audit Techniques Guide. However, the facts and circumstances surrounding each settlement payment must be considered in determining the purpose for which the money was received, since not all amounts received from a settlement are tax-exempt. Depending on the nature of your claim, you may be able to treat part of your settlement as capital gains.
If you have questions about tax liability for personal injury settlements, or if compensatory or punitive damages are taxable, Raphaelson & Levine Law Firm can help. However, some types of payments you may receive as a result of a legal agreement are taxable, whether the case is ultimately resolved in or out of court. IRC Section 104 provides an exclusion from taxable income with respect to lawsuits, settlements, and awards. There are times when the award after trial or in a settlement includes interest accrued between the time of the injury or illness and the time the plaintiffs collect their compensation.
Your negotiation should include tax considerations so that you can keep as much of your settlement as possible. Winnings from a personal injury settlement are often not taxed at all, but there are some exceptions.
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