Generally speaking, any settlement or judgment amount you receive as compensation for lost income is subject to income tax. The reasoning is that your original income would have been taxable if you hadn't suffered the loss of income, so any compensation intended to replace that same loss of income should also be taxable. The money you receive as part of an insurance claim or agreement is usually not taxable. The IRS only collects income taxes, which is the money or payment received that results in you having more wealth than before.
Taxes on liquidations can vary widely. The IRS states that money received in a lawsuit should be taxed based on its purpose. For example, if you receive earnings for lost wages in a car accident settlement, that compensation is taxable, since wages are taxable in and of themselves. When you receive a settlement, there are numerous factors related to the litigation itself, as well as the state you are in, that determine whether or not you will owe tax on that amount.
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.If lost wages are part of the award or settlement for the physical injury or illness, they are part of the compensatory damages and are not taxed. Accordingly, defendants who issue a settlement payment or insurance companies that issue a settlement payment must issue a Form 1099, unless the settlement qualifies for one of the tax exceptions. You can do this by reviewing court-related documents or other relevant settlement documentation for this information. If you have questions about tax liability for personal injury settlements, or if compensatory or punitive damages are taxable, Raphaelson & Levine Law Firm can help.
By spreading your settlement payments over several years, you can reduce income that is subject to higher tax rates. Any type of medical claim you make to the insurance will not be taxed, whether it's part of an agreement you make after an accident or simply a request for a doctor's appointment. However, some types of payments you may receive as a result of a legal agreement are taxable, whether the case is ultimately resolved in or out of court. Request copies of the original petition, complaint, or claim filed that demonstrate the reasons for the complaint and the agreement to resolve the complaint.
If you received a personal injury or illness settlement and did not take an itemized deduction for medical expenses related to the injury or illness, the total amount of your accident settlement is not taxable. If you sue for punitive damages, whether for a physical or emotional claim, you can expect that income to be taxable, since they are not intended to compensate you for your loss. Some elements of a settlement are taxable, including lost wages, pain and suffering, punitive damages, and emotional distress damages. One of the most common reasons you receive money from an insurance claim is to pay for the repair or replacement of damaged property.
You can find all of this information in the IRS Claims, Awards, and Settlements Audit Techniques Guide.
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