Whenever a large sum of money changes hands, questions about taxation inevitably arise. Most people generally understand how to pay taxes on their steady sources of income, but when an unusual financial event takes place a lot of taxation confusion tends to surround it. Lawsuit settlements are no exception.
When you or a loved one come in to a sum of money following a legal settlement, it is important to handle the taxes on it properly. Different rules apply based on the type of money you receive. Below is a summary of settlement tax rules. Understanding what type of settlement you are receiving can help you to understand and plan for the taxes you will be subject to.
- Punitive damages are always taxable. If your settlement includes financial damages that are meant to create a financial hardship for the perpetrator, then you will always have to pay taxes on that money.
- Damages paid for physical injuries are tax free. If you receive a settlement that is meant to cover your medical bills, then you will not be taxed on that money. However, if you receive money meant to compensate for mental or emotional distress, then that money is subject to taxation.
- Generally speaking, taxing rules depend on the “origin of the claim.” Ask your attorney to talk you through the origin of your legal claim, and to help you to understand what taxes you will or will not be subject to based on the claim itself and the type of damages you are receiving
Unfortunately, when it comes to the question of whether or not a settlement is subject to taxation, the answer is “it depends”. If you are seeking or anticipating a financial settlement, then it will be in your best interest to engage a financial adviser right away. They can help you to understand your taxation obligation and can help you to plan out the handling of your settlement.
This is a complicated area of tax law. Do not attempt to navigate these tricky waters without the help of a professional.