If the settlement agreement says nothing about whether the damages are taxable, the IRS will analyze the payer's intention to characterize the payments and determine the filing requirements of Form 1099.Taxes on liquidations can vary widely. The IRS states that money received in a lawsuit should be taxed based on its purpose. The tax liability of recipients of court settlements depends on the type of agreement. In general, damages for a physical injury are not considered taxable income.
However, if you have already deducted, for example, your medical expenses from your injury, your damages will be taxable. You can't get the same tax relief twice. Compensation for physical injuries and medical conditions is tax-free. When a person experiences pain, suffering, and emotional distress from physical injury or illness caused by another party's negligence, that compensation is tax-free.
There is also post-trial interest, which accumulates between the judgment and the time the settlement is actually paid. It's even more important now with higher taxes in lawsuit settlements under the recently passed tax reform law. Cases handled by personal injury lawyers are an exception to any revenue-sensitive settlement award. During agreement negotiations, you can negotiate to assign a larger part of the agreement to non-taxable award categories.
You can find all of this information in the IRS Claims, Awards, and Settlements Audit Techniques Guide. The rules are full of exceptions and nuances, so be careful how settlement awards are taxed, especially post-tax reform. When you talk to these professionals, you can learn how to avoid paying taxes in a lawsuit settlement and keep more of the money for yourself. Winnings from a personal injury settlement are often not taxed at all, but there are some exceptions.
It is so crucial to identify what amount of settlement is related to personal injury, mainly because that settlement will, more often than not, be a more significant amount than the settlement of the non-personal injury claim. They could get a settlement for their physical injuries, called “compensatory damages,” and then some punitive damages in addition, if the other party's behavior warrants it. Even if your dispute relates to a course of conduct, the total settlement will most likely involve several types of consideration. If the agreement is subject to a confidentiality agreement, the defendant cannot deduct his payment from the settlement or his attorney's fees, in fact.
Before signing any final settlement offer, make sure you understand which parts of the payment are taxable. If you don't have documentation on the amounts of each claim, the IRS will challenge the non-taxation of the settlement. If you were injured in an accident caused by the negligence of another party, the legal process can often take months or years before an agreement or payment can be reached.