Uncle Sam enjoys a good lawsuit settlement or two or three

July 01, 2014 by Eric Linden
Gavel

You fell down some stairs outside Zippo’s Supermart after an employee left a mop right smack dab in the middle of the walkway. Seeking justice and all, you file suit against this retailing behemoth. After a mountain of paperwork, depositions, and some negotiation, they settle. You receive a decent settlement and plan to book a nice vacation to Fiji. Oh, and buy a home for your mother. You may have forgotten one little thing: TAXES. Yes, Uncle Sam loves lawsuit settlements just like plaintiffs do. Before you start spending the money, there are some things you need to know. There is both good news and bad news:

Settlements from a lawsuit that are taxable (the bad news):

• A settlement that replaces taxable income (e.g. , lost wages due to the accident)
• Damages paid for personal injuries that are not physical injuries (e.g. slander, defamation, breach of promise)
• Insurance reimbursement of medical expenses that were deducted in an earlier year (BUT only to the extent of the tax benefit received in the prior year)
• Punitive damages, even for physical injury other than for certain wrongful death claims
• Interest on any award
• Amounts received in settlement of pension rights (and you have no basis in the pension)
• Damages for patent or copyright infringement, breach of contract, or interference with business operations

Settlements from a lawsuit that are NOT taxable (the good news):

• Damages received for physical injury (includes emotional distress)
• Property damage, as long as the payment does not exceed basis (not the cost to replace item)
• Refund of the price paid for goods or service if the expense was not deducted in a prior year
• Damages in cases of nonphysical injury equal to the amount of medical expenses for treatment of emotional distress
• Insurance reimbursements of medical expenses not previously deducted on a tax return

The tax ramifications for lawsuit settlements can be tricky to understand, and we highly recommend you consult a qualified tax professional if trying to determine how much of it you need to set aside so Uncle Sam has funds for new highways and drones for counter surveillance.

Tags: IRS, tax planning

Recent Articles

Refund check laying on top of a $100 bill
An IRS Notice CP32A is informing you that your refund check has not been claimed. To resolve this notice, you must call to request a new refund check.
Woman Reading Letter
IRS Notice CP21C is sent out when a taxpayer requests to make a change to their tax return. The notice informs the taxpayer that the change has been completed.
House for Sale
Details regarding the disposition of grouping of activities in order to more easily satisfy the material participation requirements for the RE Pro status.
Man opening a letter
IRS CP06A notice asks you to verify the Premium Tax Credit you claimed on your tax return with documentation. How should you properly respond to this notice?
This blog does not provide legal, financial, accounting, or tax advice. The content on this blog is “as is” and carries no warranties. TaxAudit does not warrant or guarantee the accuracy, reliability, and completeness of the content of this blog. Content may become out of date as tax laws change. TaxAudit may, but has no obligation to monitor or respond to comments.