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Grand Rapids, MI 49503
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Do You Have to Pay Taxes on a Lawsuit Settlement?

February 18, 2013Taxes

Do You Have to Pay Taxes on a Lawsuit Settlement?

With April 15 approaching, people are starting to think about taxes. So what happens if you settled a lawsuit this year? Do you have to pay taxes on your legal settlement? 

Well, it depends on what the settlement was for. The IRS generally breaks legal settlements down into 2 categories: (1) Legal settlements to compensate for physical injuries, and (2) Everything else (non-physical injuries, lost wages, business issues, etc.).

Legal settlements resulting from physical injuries.

Legal settlements resulting from physical injuries are not considered taxable income. So if you get in a car accident, sue the other driver for your injuries, and win, your award will not be considered taxable income. Additionally, if your award includes lost wages, medical bills, or other compensatory damages, those amounts also are not considered taxable.

Legal settlements for personal claims.

What if you sue your business for wrongfully termination? That settlement is taxable. And, intuitively, that makes sense — you feel like you should have been paid your wages, but you were fired instead, so you sued. Had you not been fired, you would have received those wages (and paid taxes on them). So the settlement is putting you back into the place you would have been without the wrongful act of your employer – tax liability and all.

What about severance pay?

Is severance pay taxable income? Sure is. The IRS treats it as ordinary wages.

What about for a business? 

Let’s say you’re run your own small business as an LLC or corporation — if you sue someone for not paying you for your serves, and win (or reach a favorable settle), does the business have to count that as taxable income? Yes. The IRS will see that settlement as a replacement for the income you would have received had the other party simply paid your

Now, not every business lawsuit will result in a taxable settlement. What if your business owns the building in which you operate, and someone crashes their car through one of the walls? A settlement for property damages is generally not taxable. So if you receive a settlement to cover the repairs, that amount is likely not taxable income (with some limitations depending on the value of the building in comparison with the amount of the settlement).

Note: If you received a settlement in 2012, be sure to talk with your accountant about how to report it on your taxes. Do not rely on the information in this article as a substitute for having your personal situation reviewed by a qualified tax professional.

If you have questions about this article, or there are other legal issues you need help with, contact Grand Rapids Attorney Todd Neckers at (616) 422-5082 or contact@neckerslaw.com.

The information on this blog is for informational purposes only. The posts are not intended to be legal advice. No attorney-client relationship is formed nor should any such relationship be implied.

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