If you have been engaged in a costly or lengthy legal battle, the prospect of receiving settlement money owed to you is most likely a very welcome idea. With any form of income, however, comes the inevitable question of tax liability. Depending upon the specific nature of the settlement, you may or may not be required to pay tax on settlement monies. Understanding the specifics of these deductions can help ensure that you are fully prepared with a solid financial plan when the time comes to file your taxes.
Determining Whether Or Not You Owe Tax
If you have received a settlement in a civil case, the chances are good that the Internal Revenue Service (IRS) will expect for this sum to be reported as personal income. However, if you have been awarded lawsuit money for a case involving personal injury, the IRS does not tax this money. A slightly more complex situation involves an emotional distress lawsuit settlement. Although the IRS does not consider emotional trauma to be eligible for taxation exemptions, any money you have spent on psychiatrists or counselors may qualify for an exemption.
In the event that a portion of your settlement is used to pay attorney fees, the IRS will still require you to report the full amount as income (assuming the settlement was not for personal injury). However, you are eligible to deduct these fees as part of your 2017 miscellaneous itemized deductions within your income tax return. For tax years 2018 through 2025, the miscellaneous itemized deductions have been eliminated.
Insurance Settlement Exception
If your settlement money has been granted to you as part of an insurance settlement rather than a legal case, tax is generally not required. This assumes, however, that the money awarded to you serves the purpose of rendering your situation "back to normal" rather than to generate funds that had not existed previously.
Filing Your Return 2018
If your lawsuit money is eligible for taxation, you will report these funds using the new IRS Form 1040. Although personal income tax rates are likely to fluctuate and influence your overall tax bill, the method for reporting these legal settlements will remain relatively unchanged. With that in mind, individuals can begin preparing their tax return information related to their legal settlements well in advance of filing season in order to ensure that they have the information they need to maximize their deductions and save as much money as possible.
Income Bracket Changes from 2017
Although the process of filing your Form 1040 remained relatively unchanged for tax years 2017 and prior, the lump sum you receive from your settlement may alter your tax bracket classification for the tax return for the specific year you're filing. A detailed description of the new tax brackets can be found here. As you can see from the link provided, not only have the individual taxation rates changed at times, but also the income brackets corresponding to the particular rates themselves. Those with a desire to better plan their tax filings for next year could benefit from consulting these tables well in advance of filing their return.
Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.