If you are wronged or injured in some way, you may be entitled to a lump sum settlement from an insurance company or from a lawsuit. A portion of the money you receive may have to be paid to the Internal Revenue Service in taxes.
You typically do not have to pay taxes on money received for an injury settlement. For example, if someone hits you while on the road, that person's insurance will usually pay you an amount for pain and suffering. This money is to compensate you for the loss of normal use of your body and for the pain that you experienced.
If you receive a lump-sum settlement and part of it is designed to repay you for lost wages, then you will have to pay taxes on that portion. Had you not been in an accident and lost your ability to work, you would have continued paying taxes on your income. Consequently, if you are in an accident and cannot work, you still have to pay taxes on the money allocated as income.
Money you receive from a lump-sum settlement for property damage is not taxable. This money is specifically designated to return your property to the condition it was in before the damage occurred. You can use the money to repair or replace the damaged property.
Any interest you receive on the amount of a settlement is taxable. The money could accrue interest if it takes time to put the settlement together. If you invest your lump-sum payment in an annuity or some other investment, you must pay taxes on any money you earn in interest.
- Oregon Live; Are Lawsuit Settlements Considered Taxable or Non-Taxable Events?; Kathy Howell; October 2008
- Free Advice: Can I Invest My Tax-Free Lump Sum Settlement and Still Qualify for Tax-Free Benefits on the Earnings?
- Disability Insurance Lawyer; Disability Insurance Lump Sum Settlement - Taxable or Not?; James Newfield; November 2010
- Bankrate.com; Are Insurance Settlements Taxable?; George Saenz; September 2008