Are Lawsuit Settlements Taxable ?  

        Lawsuits can be of two kinds -- those settled in-court and those settled ‘out of court’. When it comes to taxes being applicable, all awards and settlements are classified into two categories; the first is claims made on account of physical injury, and the second is claims related to non-physical injury.

        The above two categories can be further divided into punitive damages, emotional damages and actual damages. Punitive damages are usually awarded when the offense has been committed deliberately, and the amount decided on towards settlement is taxable, even if was received to compensate for physical injury.

        Actual or compensatory damages are for granted for losses due to a real damage, including something intangible as suffering. The tax structures on compensatory damages differ according to its nature.

       

         Compensatory damages received for lost income because of physical injury are not taxable, but a settlement received for emotional damage not caused due to any physical injury is. Settlement that is granted for mental stress due to physical injury is again not taxable. In standard cases, settlements received towards compensation for any physical injury that falls under dismemberment, mutilation or accidental death, as well as mental stress due to physical injury, is tax exempted. If it is for lost business, the amount received in the settlement is taxable, since the lost income is considered originally taxable.

        At times, taxable lawsuit settlement amounts are broken down into monthly annuity. These are tax free and often looked at as a great way to reduce the burden of taxation. However, it is a must that a tax attorney or advisor is always consulted in such matters.

 

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