Many of us come across advertisements for personal injury lawyers seeking to represent individuals who have been injured. These lawyers often guarantee significant compensation and display contented clients. What these ads typically omit is the fact that taxes will be owed to the federal government on any settlement funds received.
Settlement funds from various legal cases such as slip-and-fall accidents, car accidents, personal injury lawsuits, insurance claims, and even non-litigated situations like termination agreements may be subject to federal income tax. Settled legal cases commonly involve different components like compensatory damages, emotional distress damages, and attorney fees. While some elements of the settlement may be taxable under federal law, others might be exempt depending on the terms of the settlement agreement.
The Internal Revenue Service (IRS) addresses taxation on settlements and judgments in the Internal Revenue Code (IRC) Section 61. As a general rule, all income is taxable unless specifically exempted under another section of the IRS tax code. Various exemptions exist for certain types of settlements, such as those related to discrimination claims and physical injuries. The IRS distinguishes payments pertaining to physical injuries from those linked to non-physical injuries, categorizing them into actual damages, emotional distress damages, and punitive damages.
It is crucial to seek guidance from a tax attorney and accountant when dealing with settlements, as the tax implications can be complex and varied. Proper planning and structuring of settlements can potentially mitigate tax liabilities or facilitate tax-free treatment of settlement proceeds. Various types of settlements, like those stemming from personal physical injuries, are typically exempt from federal taxation, whereas punitive damages and certain employment-related settlement sums are taxable under federal guidelines.
To ensure a settlement is structured in a tax-efficient manner, consulting with legal and financial professionals is advisable. They can help tailor the settlement terms to benefit your tax situation and potentially reduce tax obligations associated with the settlement proceeds.