How is settlement income reported?

If you receive a taxable court settlement, you could receive Form 1099-MISC. Your liquidation income will be reported in Box 3, for other income. This is particularly true for federal income tax matters and the proper characterization of a settlement payment. For example, characterizing a settlement payment as a payment for damages due to defamation or a payment in lieu of loss of profits results in revenue for the payee.

In contrast, characterizing that same payment as a payment for physical injury or a return of principal does not imply any tax for the recipient. With ordinary income tax rates as high as 37 percent, the difference in characterization in these cases can result in a lot of income tax or no income tax at all. If the settlement results in a series of payments to the plaintiff over a period of time, these checks must also be made payable directly to the plaintiff. The first step in determining the taxation of the proceeds of the liquidation is to determine what exactly is being paid.

Settlement money and damages collected in a lawsuit are considered income, which means that the IRS will generally tax that money. The two main methods of reporting the settlement to the IRS are Form W-2 or Form 1099-MISC. The third exception for when attorneys' fees are not included in the plaintiff's income is when the fees are the expenses of another person or entity, such as when a union files a lawsuit against a company. Even if an employee is no longer employed at the time of settlement payment, the payment is still considered salary subject to withholding tax.

Any pre-trial or post-trial interest in settlement money is taxable and may influence taxes on some attorney's fees. The IRS will accept the settlement agreement as binding for tax purposes if the agreement is entered into in a context of confrontation, on an equal footing and in good faith. If they are found to be non-collectible, the employer will be forced to pay the portion of the taxes that the IRS believes it should have withdrawn from a settlement payment. Just because the customer could have agreed to accept the agreement in December does not mean that the customer has a constructive receipt.

Settlement payment requires consideration of reporting obligations and taxes that must be withheld from payments accordingly. 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. Finally, the IRS states that attorneys' fees for wage claims are in themselves wages subject to labor taxes, unless the settlement agreement expressly provides for an allocation for attorneys' fees. Even if the defendant pays the lawyer separately, and even if the plaintiff receives only the net settlement after the legal fees, 100% of the money is considered received by the plaintiff.

Property damage agreements for loss of value and property are not taxable and generally do not need to be reported on the tax return. If the plaintiff is going to attempt to claim that the settlement proceeds are excludable from their taxable income, the burden is on them to prove this position to the IRS.

Minnie Wuestenberg
Minnie Wuestenberg

Total pop culture nerd. Hardcore twitter guru. Incurable foodaholic. Hardcore troublemaker. Friendly coffee lover. Unapologetic food junkie.

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