Are court settlements taxable? (2023)

Are court settlements taxable?

Finally resolve your claim. Most lawsuits attempt to restore the plaintiff's health after an injury or other loss. Part of your settlement agreement requires the at-fault party to pay damages. Can't wait to get money to cover the costs of your injury and plan for the future, but have to pay taxes on the money you get from a court settlement?

As with any tax question, the answer is complex and confusing. Each case is different, but depending on the type of claim and other circumstances, you may be required to pay taxes on the compensation you receive. Here are some general tax guidelines; However, you may need to consult a tax expert about your case because the IRS has determined that settlements are taxable in certain complicated circumstances. Read on to learn more about the tax requirements for a personal injury settlement.

Types of legal agreements

In terms of terminology, a trial refers to a formal judicial settlement of a dispute in which the court can order one party to pay damages to the other. Agreement refers to a mutual agreement between the parties to the process. Settlements are a separate process from court proceedings, binding arbitration, or other types of formal hearings. However, from a tax standpoint, judgments and settlements receive the same treatment.

The general rule to tax the amounts received in the resolution of judicial processes and other legal actions isSection 61 of the Internal Revenue Code (IRC), which states that all income is taxable "unless there is a specific exception from a derived source, unless otherwise exempted by another section of the Code."

Some types of compensation are almost always taxable, such as:

  • Interest on cash prizes
  • Most payments for lost wages or lost earnings
  • Patent Infringement, Copyright Infringement, or Breach of Contract
  • Money received to settle pension claims

Perhaps the biggest exception to this rule concerns personal injury compensation settlements. The IRS excludes some, but not all, income from litigation, settlements, and tax premiums.

What happened that led to the comparison? What is the situation and what is the money for? The question is: what should replace the compensation received?

(Video) Is My Settlement Taxable?

If you reach an agreement in a court proceeding, this may be for a number of reasons. Your consent may constitute compensation for losses resulting from personal injury or damage from any other type of injury. Some or all of the compensation may come from different types ofemotional sufferingor punitive damages awarded by the court for the scandalous conduct of the defendant.

source of demand

The facts and circumstances of each case vary. The IRS typically assesses claims based on the source of the claim, which depends on the claim reason on which the claim was based.

A claim arising from an injury sustained in an accident may have more than one type of claim. Some of these are taxable, some are not. In certain business disputes, the IRS will tax compensation for lost profits as ordinary income. Depending on the circumstances, an award for lost wages, wrongful termination, or compensation may be taxed as income. If you receive compensation for damage to your home caused by a negligent contractor instead of taxable income, the IRS may treat that compensation as a reduction in the purchase price of the property. Of course, complicated rules are full of exceptions.

Are claims settlements taxable?

The simple answer to this question is no. Personal injury compensation payments are not taxable if they demonstrate observable bodily harm. Therefore, if the injuries are visible or physical, the IRS will treat the settlement money resulting from those injuries as nontaxable and excluded from the income portion of your tax forms.

Therefore, if you sue after suffering bodily harm, e.g. For example, in a car accident or other type of personal injury, the IRS will treat the compensation you would receive after settlement as nontaxable. Please note that this does not include punitive damages imposed by the federal government. Personal Injury Tax StatusSettlements can be confusingbecause compensation in personal injury cases often includes compensation for losses such as B. lost wages that would otherwise be taxable.

Regardless, as long as the source of the claim is based on physical injury or physical illness, these claims for damages are tax-free.Article 104 of the Tax Code🇧🇷 However, if you have deducted medical expenses in previous years, you must declare the compensation payments as income since you cannot use the same tax benefit twice.

Examples of invisible harm include sexual harassment, slander, or defamation. Emotional stress is different from non-visible injuries, but it is treated in a similar way.

Compensation for emotional stress.

However, reimbursements for personal injuries and physical illnesses are tax-free.The symptoms of emotional distress are not physical🇧🇷 This area of ​​law is getting very complicated. Did the physical injury cause emotional distress or did the emotional distress cause the physical symptoms? Simply put, if the defendant caused your physical injury, it's a tax-exempt event, but if the emotional distress caused you a physical illness, it's probably taxable.

(Video) How Lawsuit Settlements are Taxed (by John M Miller, CPA)

Before 1996 personal damages were not taxed. Therefore, settlements of claims such as emotional distress and libel were tax-free. However, since 1996, severance payments for property damage only are not taxable. compensation foremotional sufferingIt is not taxed only if it arises from a bodily injury or physical illness.

While damage caused by emotional stress is generally taxable, the amount you must include on your taxes is reduced by:

  1. Amounts paid for medical expenses attributable to emotional distress or psychological distress not previously deducted, and
  2. Medical expenses previously deducted for those ailments and conditions that did not generate a tax benefit.

Sometimes it is difficult to determine the taxable status of a liquidation price. for example indomain v notary, the author had multiple sclerosis. His condition worsened due to stress at work. Her employer fired her, which made her condition even worse. She settled her employment law case.

Ultimately, the Court of Finance ruled that the claimant's illness had been aggravated by the actions of her employer and that therefore part of her severance pay was tax-free. The tax court said the IRS's assertion that a person can never have physical injury or physical illness in an emotional distress claim was incorrect.

Courts have distinguished between signs of emotional distress and symptoms of emotional distress. A symptom is a "subjective indication of a disease of a patient's condition". Emotional stress, on the other hand, can be accompanied by physical symptoms such as abdominal pain, headache, and upset stomach, but it is not generally considered a physical injury or illness. On the contrary, a sign is perceptible evidence for the examining physician.

punitive damages

A court may award punitive damages. The courts grant these compensations as punishment to those responsible for the process. Courts generally award punitive damages when a defendant's actions involve immoderate behavior, such as fraud, malice, recklessness, or outright disregard for the plaintiff's rights and interests. They are not granted as compensation for the injured party and are independent of the compensation.

Punitive damages are generally taxable; but it depends on the state. For example, personal injury settlements, including punitive damages, are not taxable.Pennsylvania Income Tax Law.

legal fees

Attorney fees are another complex area related to tax filing. If your attorney is representing you in a personal injury case on a contingency fee, you may be taxed on 100% of the money you and your attorney recover. This also applies if the defendant pays the contingency fee directly to him.Personal Injury Lawyer🇧🇷 If your severance pay is not taxable, such as a car accident injury settlement, you shouldn't have a tax problem.

(Video) Robert Wood on Not Losing Your Settlement Money to Taxes

If your recovery is taxable, the situation is more complicated. For example, when you are settling a lawsuit for emotional distress. Your settlement gives you $200,000. If legal fees are $80,000, take home $120,000. Logically, you might think that you have $120,000 of income to claim for tax purposes. However, the IRS says you must claim the $200,000.

Withincommissioner v. banks, the US Supreme Court ruled that a plaintiff's taxable income generally equals 100% of his severance pay. this is the caseeven if their lawyers cooperate🇧🇷 Also, in some cases, you may not be able to deduct legal fees from your taxable income.

By assigning damages, taxes can be saved

Of course, you want to do everything possible to minimize the tax consequences of a deal. Tax planning opportunities may arise when negotiating an agreement, although the IRS can challenge the agreements. To determine whether you received some or all of your compensation for personal injury or sickness, the IRS reviews documents such as the application, the hearing, and the actual compensation document.

The tax language used in a settlement agreement is not binding on the IRS or courts in subsequent tax disputes, but the document should be as tax specific as possible. Most of the litigation involves complicated scenarios and various related issues. Even if your dispute relates to the main issue, the resolution may involve more than one consideration.

If the parties agree to a tax treatment, the IRS considers the parties' intent when deciding whether to exempt an agreement from tax, although it is not required to do so. If the settlement agreement is not tax related, the IRS will consider the intent of the payer in determining the tax status of the settlement payments.

In some cases, it is possible to divide damages among multiple claims. For example, some damages may be due to personal injury or illness that is not taxable. Others may pay for emotional distress that is generally taxable.

To avoid paying rent due to illness or personal injury, keep all evidence related to the claim and all evidence that the defendant was aware of the claim and considered paying it. Medical records can help determine that the defendant caused or aggravated the injury. Statements from treating physicians and specialists may be helpful. All of this evidence is helpful when it comes to an IRS application or audit.

Consider the potential tax implications when negotiating a settlement agreement and before signing it. Once you have signed the contract, you will not be able to change it.

(Video) Don’t Lose Your Settlement Money to Taxes! | Robert Wood

Why are tax considerations important?

During a court proceeding, the primary focus for most people is the outcome and the amount of damages awarded. To make it easier to pay early, people may not consider the taxes you may have to pay on the settlement amount.

By now, you've probably faced numerous challenges, including a painful recovery and financial loss. You and your attorney fought hard to obtain compensation that would cover the full cost of your injuries. After dealing with physical and financial recovery from an injury, the last thing you want is to deal with the IRS. The goal is for you to keep as much of your settlement value as possible to aid in your recovery.

Determining the taxes on your settlement can be difficult, so it is important to be involved in this final step of the settlement. Of course, there are general rules about how much tax you pay on the settlement amount. However, you should discuss the situation with your attorney and a tax professional for advice, as there may be something you can do to reduce your taxable income. For more information, contact an experienced personal injury attorney today.


1. What is a Lawsuit Settlement Tax
(Lawyers Guide)
2. Are lawsuit settlements taxable? | Northern Indiana Attorneys Full-Service Attorneys
(Blachly, Tabor, Bozik & Hartman, LLC)
3. Are Personal Injury Settlements Taxable?
(Bononi & Company, P.C.)
4. (TLF) Are Settlements Taxable
5. Are Personal Injury Settlements Taxable? The Surprising Truth
(Kyle Newman Esq)
6. Are Personal Injury Settlements Taxable?
(The Brown Firm)


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