How Much Tax Would I Pay on Lawsuit Settlement Money?
Winning a lawsuit and obtaining settlement money for some kind of injury or loss you had may give you a good feeling. Unfortunately, you can't make any money without the IRS wanting its share of it. But even though the IRS taxes most of any earnings we make, there are loopholes in situations involving settlement money that could help you avoid paying taxes on it. How much you pay will depend on how big the settlement is.
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Settlements for Illnesses, Injuries or Mental Anguish
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Generally, this type of settlement will be taxed if you took a deduction on medical expenses in your past tax returns. Based on logic, most people would take the deduction after suffering a physical injury or illness. However, in the chance you didn't, you won't have to pay taxes on a settlement of this kind. If you win a settlement for mental anguish or emotional distress, you generally have to report it if the amount you received goes beyond what you paid in medical expense. Again, if you didn't take medical deductions or the settlement is below your medical expenses, you won't have to report settlements for mental anguish.
Settlements on Discrimination in a Job
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According to TaxMama.com, the IRS will consider settlement money taxable income if you received the settlement upon being discriminated against in a job or if your reputation was tarnished. In fact, all punitive damage settlements are considered income without any exceptions.
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Settlements From Stock Market Losses
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In a March 2008 article on Kiplinger.com by Kevin McCormally, it was reported that many class-action lawsuits were filed over stock market losses in recent years. During the settlement process, one has to consider what actually happened to determine taxes. If you were overcharged for the stock, then you won't have to pay taxes on it since it's considered a refund. But when you sell the stock, it's considered a capital gain. You'll have to report that on a 1040 Schedule D form (see Resources).
Interest on Settlements
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In many cases, interest may accrue on a settlement before it's even paid out to you. If this happens, report it under Interest Income on your normal 1040 form.
How Much You Could Pay
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TaxMama.com says that large settlements that garner tax payments of $1,000 or more will usually mean having to pay estimated taxes. The IRS says this type of tax is used when you get income from different sources that aren't consistent, such as dividends, capital gains or royalty payments.You need to fill out a 1040-ES form to report your estimated tax in such a situation (see Resources).
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References
- TaxMama.com: Settlement Award? Uncle Sam May Be Waiting in Line
- IRS: Market Segment Specialization Program -- Lawsuits Awards and Settlements
- Weitz & Luxenberg P.C.: Lawsuit Awards and Settlements: IRS Tax Law
- Kiplinger.com; Reporting Lawsuit Settlements; Kevin McCormally; March 2008
- IRS: Tax Withholding and Estimated Tax
Resources
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