Whether or not you must pay taxes on a negligence settlement depends upon the nature of the damages. While negligence usually refers to personal injury, that’s not true in every case. Keep in mind that settlements often have multiple elements, some of which are taxable and some of which are not.
Negligence settlements dealing exclusively with personal injury are not taxable.
Understanding Lawsuit Settlements and Taxes
In a negligence case involving personal injury, the settlement for your personal injuries is not taxable unless you deducted your medical expenses on your federal income tax return in a previous year. If that’s the case, you must include the amount deducted as “other income” on line 21 of Form 1040. If you received damages for emotional distress relating to your personal injury, that amount of the settlement is not taxable. However, if you received damages for emotional distress that was not related to personal injury, you will owe taxes on the amount. If the jury awarded you punitive damages in relation to your personal injury case, those damages, meant to punish the defendant, are taxable.
If you were personally injured by a doctor or hospital and filed a medical malpractice claim, it’s likely that most, if not all, of the malpractice settlement isn’t taxable. If you were involved in a motor vehicle accident and suffered a personal injury, the settlement amount relating to your personal injury is not taxable. However, if your car was wrecked in the accident and you were awarded money for your vehicle, the property damage settlement is taxable. Compensatory damages are taxable, as they replace what was lost and nothing more.
2018 Lawsuit Settlement and Taxes
The Tax Cuts and Jobs Act, signed into law on Dec. 22, 2017, changes the way some settlements are taxed, although it does not affect most personal injury cases relating to negligence. Plaintiffs may find themselves taxed on the gross amount received, without a deduction for legal fees. In a contingency case in which the attorney takes 40 percent of the settlement, that means the plaintiff will face taxes at ordinary income rates on the entire amount. That means that in a $1 million settlement in which the lawyer takes $400,000 of it in fees, the plaintiff is taxed for the settlement, not the $600,000 they actually received. The new law ends the practice of deducting legal fees as a miscellaneous expense if they met income guidelines.
2017 Lawsuit Settlement and Taxes
If you received a taxable settlement in 2017, you can itemize your deductions and deduct legal fees as a miscellaneous expense if these fees were more than 2 percent of your adjusted gross income.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Financial Advisor, Sapling, nj.com and The Nest.