LAWSUIT SETTLEMENT TAXATION: IRS PUBLICATION #4345
If you receive proceeds from a settlement of a lwasuit, this article provides information about whether you must include the proceeds of certain kinds of settlements in your income.
Personal Physical Injuries or Physical Sickness
If you receive a settlement for personal physical injuries or physical sickness------------AND did not take an itemized deduction for medical expenses related to the injury or sickness: THE FULL AMOUNT IS NON-TAXABLE. Do not include the settlment proceeds in your income.
BUT
If you receive a settlement for personal physical injuries or physical sickness, you must include in income that portion of the settlement that is for medical expenses you deducted in any prior year(s) to the entent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro-rata basis the part of the proceeds for medical expenses to each of the years you paid medical expenses. IRS Publication #525 "Recoveries" section shows how to calculate the amount to report. The tax benefit amount should be reported as "Other Income" on line 21 of Form 1040, Schedule 1.
Emotional Distress or Mental Anguish
The proceeds you receive for emotional distress or mental anguish originating from a personal physical injury or physical sickness are treated the same as proceeds received for Personal Physical Injuries or Physical Sickness above.
BUT
If the proceeds you receive for emotional distress or mental anguish did not originate from a Personal Physical Injury or Physical Sickness, you must include them in your income. However, the amount you must include is reduced by:
A-Amounts paid for medical expenses attributable to emotional distress or mental anguish not previously deducted, and
B- previously deducted medical expenses for such distress or anguish that did not provide a tax benefit.
*Attach to your return a statement showing the entire settlement amount less related medical costs not previously deducted and medical costs deducted for which there was no tax benefit. The net taxable amount should be reported as "Other Income" on line 21 of Form 1040, Schedule 1.
Lost Wages or Lost Profits From Your Trade or Business
If you receive a settlement in an employment-related lawsuit, the portion of the proceeds that is for lost wages is taxable wages and subkect to the social security wage base and social security and Medicare tax rates in effect in the year paid. The proceeds are subject to employment tax withholding by the payor and should be reported by you as "Wages, Salaries, Tips, etc" on line 1 of Form 1040.
If you receive a settlement for lost profits from your trade or business, the portion of the proceeds attributable to the carrying on of your trade or business is net earnings subject to self-employment tax. These proceeds are taxable and should be included in your "Business Income" reported on Line 21 of Form 1040, Schedule 1. These proceeds are also included on Line 2 of Schedule SE, Form 1040 when figuring self-employment tax.
Loss-In-Value of Property
Property settlements for loss in value of property that are less than the adjusted basis of your property are not taxable and do not need to be reported on your tax return. However, you must reduce your basis in the property by the amount of the settlement.
If the property settlement exceeds your adjusted basis in the property, the excess is taxable income----which will be reported either on Schedule D, Form 1040 or Form 4797,depending on the property.
Punitive Damages
Punitive damages are taxable and should be reported as "Other Income" on line 21 of Form 1040, Schedule 1, even if the punitive damages were received in a settlement for Personal Physical Injuries or Physical Sickness.
Interest Income Earned Settlements
Interest on any settlement is generally taxable "Interest Income" and should be reported on Schedule B and line 2b Form 1040.
TAX TIP: Estimated Tax Payments
If you have taxable income from a settlement, you may need to make estimated income tax payments to the IRS to avoid an unexpected tax bill at tax time, along with possible IRS penalties and interest.
TAX TIP: HEALTH INSURANCE THROUGH THE MARKETPLACE
If you are enrolled in health insurance coverage through the Health Insurance Marketplace and advance payments of the the premium tax credit are made, let the marketplace know to that the marketplace can adjust the amoount of your advance credit payments, which helps prevent large differences between your advance credit payments and the premuim tax credit you are allowed and, potentially, an increase in your tax bill. IRS PUBLICATION #5152 has information about reporting changes to the Marketplace.
TAX TIP: DISCUSS TAX ISSUES WITH YOUR LEGAL TEAM
Be proactive and discuss potential taxation issues with your legal team to better plan and prepare for potential tax consequences.
CALL NOW 561-746-1926 or 561-339-8102 if you have any questions or concerns or would like to schedule a FREE, Confidential, No-Obligation Tax-Saving Consultation.