This short guide cannot explain all the factors involved, but will give you a broad overview on how to understand taxable settlements. You may think that when you are awarded a settlement in court you will not have to pay tax on it. However, with issues ranging from wrongful death settlements to slip and fall settlements, tax laws can be complicated and quite tricky to predict which ones you'll have to pay taxes on.
Things You Will NeedA current or future tax settlement
Step 1Whether or not you have taxable settlements depends largely on what the settlement was awarded for. In cases of personal injury, where more than one factor is taken into account, you may find that some parts of your settlement are taxable and some are not.
Step 2Since August 1996 settlements made in court only become taxable settlements when they are not awarded for either physical injury or physical sickness. The term 'physical' is of importance here, because when a settlement is made purely for the physical effects of injury they do not have to be declared as gross income on a tax return form.
Step 3Any settlements made to compensate you for emotional distress, however, do not count as physical injury or sickness settlements and therefore are taxable settlements treated in the same way as gross income.
Step 4Now it gets complicated. Whilst money awarded for emotional distress is taxable, the settlement awarded to pay for the medical bills which are incurred during the treatment of the distress are not taxable settlements.
Step 5Your income and expenditure will have to be declared on your annual tax return form, and these amounts will include income both from taxable settlements and expenses occurred for medical bills. You do not have to include as taxable income that part of any settlements which were for personal, physical sickness or injury as these are not counted as taxable income by the IRS.
Step 6Awards made for punitive damages are taxable. What are punitive damages? These are taxable settlements which exceed the amount needed to compensate the plaintiff for either physical or emotional damages and are awarded as a punishment, as the name implies, in cases of extreme or willful damage. Whilst such settlements may seem to compensate for emotional distress, they are taxable, and must be included as income for tax purposes.