If you’ve won a lawsuit, you'll want to know how much of the money will go to your attorney and how much you’ll end up paying in taxes. While the percentage going to your lawyers depends on your agreement with them, the IRS is straightforward about taxes on a lawsuit settlement. Taxes on lawsuit money depends on the nature of the suit.
If you are required to pay tax on lawsuit settlement money, it will be taxed at the standard income rates established by the federal government.
Taxes on Settlement Proceeds
If you were badly injured through no fault of your own, the good news is that money from a personal injury settlement isn’t taxable, either federally or by your state. The sort of damages you may collect because of your injury, such as medical bills, lost wages, pain and suffering and the like are not taxable. Those are known as compensatory damages.
Taxes on a Lawsuit Settlement
Some forms of settlement money are taxable as ordinary income. Even though compensatory damages aren’t taxable for personal injury settlements, that’s not the case if punitive damages are awarded. Punitive damages are meant to punish the party responsible, and such damages are separated from compensatory damages in the verdict so that it is easy for the IRS to ascertain which settlement monies fall into which category. If you received damages for emotional distress, these are also taxable if it is not related to the actual physical injury or illness.
Lawsuit money from any type of non-personal injury settlement is taxable. For example, if you filed a lawsuit against your employer for sexual harassment and received a settlement, expect to pay taxes on the entire amount. There are exceptions for physical injuries or sickness relating to the employment situation, such as injuries relating to actual sexual assault, but you must pay taxes on lost wages, damages for emotional distress and the like. Most people involved in employment lawsuits don’t suffer physical injuries, and the types of issues most workers suffer from because of a hostile work environment usually include stress, insomnia and other problems that aren’t considered physical injuries per se. Should the settlement include the employer paying your attorney’s fees, that amount is usually taxable to you. That may not prove true if it was a class-action case as long as you had a separate contingency fee arrangement with counsel or it involved an opt-out class action.
Reporting Lawsuit Money
If you must pay taxes on a lawsuit settlement, these amounts are taxed at ordinary income rates, so the percentage depends on your tax bracket. A large settlement can put you into another tax bracket for the year. If you do have to pay taxes on your lawsuit money, report it on Form 1040, line 21, “other income.” You must also report and pay taxes on interest earned on a settlement, including personal injury cases. Report such interest on Form 1040, line 8a, which is “interest income.” For example, if you received $100,000 in compensatory damages for a personal injury and $1 million in punitive damages, you won’t pay taxes on the compensatory damages but you must pay taxes on the $1 million, which should put you into the highest tax bracket percentage. For 2017, that percentage is 39.6 percent, while for 2018 it is slightly less, at 37 percent.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including Sapling, Zack's, Financial Advisor, nj.com, LegalZoom and The Nest.