Do You Pay Taxes on a Legal Settlement?
If you were injured by another party in the Las Vegas area (or elsewhere) and win a lawsuit or settlement against them, do you have to pay taxes on that money?
The short answer is…” It depends.” Read on to learn the basics of taxes for lawsuits and legal settlements.
Then see how Anthem Injury Lawyers can help you if you’ve been the victim of an accident. We can represent you if you’ve been hurt by others in auto accidents, bus accidents, pedestrian accidents, bicycle accidents, and more. Continue reading to learn more about paying taxes on legal settlements and how you can contact our Las Vegas personal injury law firm for a free initial consultation. Read to know in detail: Do you pay taxes on settlement money?
Is Your Settlement Considered Taxable Income?
Congratulations! After months (or more) of negotiations between various parties, you have finally reached a settlement or won a verdict in your lawsuit. But you may be disappointed when you actually receive your settlement payment. Many legal settlements are considered taxable income by IRS standards. Between taxes and attorney’s fees, you may end up with less money than you anticipated.
Whether or not you will pay taxes on a settlement depends on the nature of the lawsuit. The tax implications for personal injury claims are different from discrimination settlements, etc. Read on to learn more about what to expect.
Personal Injury Awards are Generally Considered Tax-Free
The good news is that most personal injury settlement proceeds are tax-free. Personal injury is defined as a physical, observable injury. If you have received a personal injury settlement, chances are that you don’t need to pay taxes on this money.
However, there are some situations where some of the money that you receive in the personal injury settlement may be taxable. One example of this is if part of the settlement money that you received is to reimburse you for medical expenses and you already took a deduction for those expenses in the past.
According to the Internal Revenue Service, “If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable.”
If, however, you deducted any of your medical bills in the years prior to your settlement, you must include the portion of the settlement that is for medical expenses in your income when you file your taxes.
This basically means that you can’t take a deduction for medical care and then get reimbursed for those expenses without paying back taxes. This gets even more complicated when the medical expenses span more than one year, in which case, you need to pro-rate them. (Refer to the “Recoveries” section in IRS Publication 525 for more details on the tax code and how to calculate the amount of your settlement payment to report on your tax return.)
Different Award Allocations Within Personal Injury Suits May Be Taxed Differently
In personal injury cases, there may be different award allocations, meaning some of the money may be awarded for different reasons, including emotional distress, lost wages, punitive damages, breach of contract, etc. It is important to know which portions of your payment are allocated to which categories, as these will be treated differently for tax purposes.
Often times within a personal injury case, money will be awarded for emotional distress, or mental anguish, that the physical injury caused the plaintiff.
Any proceeds you receive for emotional distress are treated the same as proceeds received for physical injuries or physical sickness, as long as they originate from a personal injury claim. For example, you may experience psychological symptoms in addition to physical symptoms after a car accident, and some of the settlement money you receive may be awarded for that. However, if you are suing a person or company for the emotional distress they caused, but there was no underlying physical injury or physical sickness, your award for emotional distress would be taxable.
If you were unable to work due to your injury, your settlement might include an amount to reimburse you for back pay, and the government requires that you pay taxes on those wages. The payer would issue a W2 form detailing the gross income they paid you, as well as any tax withheld. This must be included on your tax return, as with any other W2 form you receive.
Punitive damages refers to money that the defense has to pay as a punishment for wrongdoing. For example, if a healthcare company marketed a faulty device, punitive damages may be awarded to the victim to punish the defendant. Punitive damages are always taxable. Similarly, if you receive damages related to breach of contract, that money is taxable as well.
Interest income is another taxable portion of your settlement payment. Lawsuits often involve multiple parties including the plaintiff(s), the defendant(s) and insurance companies, and they can take a long time to resolve. When you finally receive your payment, you may be entitled to interest on the money that was due to you. You must pay tax on any interest that you receive.
All of these award categories are taxed as ordinary income on your tax return.
Non-Personal Injury Suits
Most non-personal injury awards are taxable. These include discrimination suits, wrongful termination, breach of contract, and more. These settlement payments are usually taxed as ordinary income according to your tax bracket, whether they are paid in a lump sum or in multiple installments.
Don’t Forget About State Taxes
Depending on where you live, state income tax can add up to almost another 10% on your tax bill. If you’re lucky enough to live in Nevada, you don’t need to worry about state tax consequences, as there is no state income tax in Nevada.
As you can see, all of these award and tax scenarios can be complicated, and you want to make sure you get these figured correctly, or you may face complex tax problems. While Nevada has no income tax, so many other tax implications exist on the federal level. If you’ve been the victim of an accident in the Las Vegas area, we recommend contacting Anthem Injury Lawyers for a Free Consultation.
Where Do Attorney Fees Come In?
If you are working with a personal injury lawyer on a contingency basis, meaning that you only pay that lawyer if and when you get paid, you will have to account for the percentage of the settlement payment that will go to your attorney. You may be responsible to pay taxes on the gross amount of your settlement, including the amount that goes to your lawyer. Talk to your attorney to understand these implications.
Why You Need to Work With a Personal Injury Attorney
Your attorney can help you navigate the different award allocations and ensure that the settlement agreement is written in such a way as to limit your tax liability to the greatest extent possible. You should never settle on an agreement until you understand what the tax implications are. Doing this beforehand can save you a lot of money and surprises when tax time comes around.
In addition to seeking legal advice, you should work with a tax professional to set aside a sufficient amount of your settlement payment for applicable taxes. You don’t want to run into any problems with Uncle Sam!
Experienced Las Vegas Personal Injury Attorneys
If you or a loved one was injured by another party, you should seek legal advice from an experienced personal injury lawyer.
The personal injury lawyers at Anthem Injury Lawyers provide exceptional representation because they are highly experienced at dealing with all types of personal injury claims—from car accident cases to medical malpractice, to dog bite cases, we have you covered.
Contact us today for a Free Consultation. Our law firm is located in Henderson, but we work with clients all over the Las Vegas, Nevada area. Call us at (702) 857-6000 or fill out our online contact form to schedule your Free Case Evaluation.