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. Awards and agreements can be divided into two distinct groups to determine whether payments are taxable or non-taxable. If you have questions about tax liability for personal injury settlements, or if compensatory or punitive damages are taxable, Raphaelson %26 Levine Law Firm can help.
If you don't have documentation on the amounts of each claim, the IRS will challenge the non-taxation of the settlement. 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. In some cases, a tax provision in the settlement agreement that characterizes the payment may result in its exclusion from taxable income. Interview the taxpayer to determine if the taxpayer provided any type of settlement payment to any of their employees (past or present).
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. Under Section 104 (a) above, late payment received to satisfy such a claim was not excludable from gross income, but damages received for emotional distress are excludable. If your case is based entirely on physical injury, for example, from a car accident, your legal agreement will not be taxed at all, no matter what your attorney's fees amount to. For example, if one lawsuit is related to personal injury and the other is a non-personal injury claim, one settlement is excluded from taxes and the other is not.
You can find all of this information in the IRS Claims, Awards, and Settlements Audit Techniques Guide. If your insurance claim has become a lawsuit, the tax situation becomes more complicated, as you could receive several different forms of compensation, all of which can be taxed in different ways. Before signing the settlement agreement, define whether or not the defendant will issue a Form 1099.Request copies of the original petition, complaint, or claim filed that demonstrate the reasons for the complaint and the agreement to resolve the complaint. Winnings from a personal injury settlement are often not taxed at all, but there are some exceptions.