Settlement money and damages collected in a lawsuit are considered income, which means that the IRS will generally tax that money. 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. Let's say you're suing for the back wages of a W-2 job.
That money would normally be taxed as ordinary income. What does that mean? You will receive a W-2 for it, and your income taxes and FICA taxes will be withheld. For tax purposes, your settlement is more or less like a normal paycheck. What does that mean for your taxes? Unfortunately, you will be taxed on the full amount of the agreement, not just the 60% you must keep.
Of course, that only applies if your agreement is taxable in the first place. When you win a deal, it can be difficult to know if your prize is taxable or not without looking into the details. It doesn't matter if the monetary compensation in your personal injury case comes from an out-of-court settlement or if it's the result of a trial verdict. In a typical settlement where you only receive compensatory and general damages for your physical injuries and medical expenses, most of that amount is generally not taxable.
If the agreement is subject to a confidentiality agreement, the defendant cannot deduct his payment from the settlement or his attorney's fees, in fact. Depending on the nature of your claim, you may be able to treat part of your settlement as capital gains. In some cases, a tax provision in the settlement agreement that characterizes the payment may result in its exclusion from taxable income. It's even more important now with higher taxes in lawsuit settlements under the recently passed tax reform law.
When you receive a settlement, there are numerous factors related to the litigation itself, as well as the state you are in, that determine whether or not you will owe tax on that amount. Section 1,104-1 (c) defines damages received because of personal physical injury or physical illness as an amount received (other than workers' compensation) through the processing of a lawsuit or legal action, or through a settlement agreement entered into rather than prosecution. The rules are full of exceptions and nuances, so be careful how settlement awards are taxed, especially post-tax reform. If your agreement or judgment includes compensation for other types of losses besides lost wages, such as medical bills, you must still pay taxes on the part of the settlement or judgment that is attributable to the loss of wages.
When you talk to these professionals, you can learn how to avoid paying taxes in a lawsuit settlement and keep more of the money for yourself. An agreement from an auto insurance company) after your car accident, or a civil court awarded you money after the trial (in other words, you received a judgment in your favor).
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