In many cases, the subject of a class action lawsuit often determines whether or not the lawsuit settlement is taxable. Lawsuit proceeds are generally taxable in cases where the lawsuit isn’t related to personal injury, unjust enrichment, misrepresentation, loss of earning capacity, depreciation of an asset, or property damage. The determination of whether the lawsuit is taxable ultimately rests on a number of factors including the type of the injury, any awards made to the individual plaintiff, any damages actually received by the plaintiff, any taxes required by the Internal Revenue Service based upon the amount of actual damages, and the extent to which any of these injuries are mitigated by the defendants’ conduct. Any damages that were awarded but not actually received are not taxable unless the proceeds are received for those damages from the defendant’s gross negligence or misconduct.
In most situations, nontaxable damages are those that result from injuries that are awarded by a state’s jury verdicts. Examples of this would be damages awarded by a state’s jury in a civil suit wherein the plaintiff was injured in an accident caused by another party’s defective product. Even if the victim was not compensated monetarily by the defendant in this instance, he or she may still have been able to recover damages through the use of tax laws and the assets of his or her attorney.
When sued in a civil case in which the defendant does not face personal injury damages, there are two possible routes available to the plaintiff in such a situation. One route requires the plaintiff to determine whether her damages are so extensive that they clearly pass the jurisdictional limits of the United States Tax Court. Specifically, the plaintiff must establish “a substantial enough connection” between the injury and the conduct of the defendant that makes a finding of negligence sufficiently severe to warrant taxation. In most cases, this requirement will also include an allowance for an injury claim to include damages for pain and suffering.
The second method used to assess whether settlement payments are taxable is whether the claims are “basically compensations” for loss. To determine whether such settlements are basically compensations for loss, it is necessary to look at both the settlement payment and the tax consequences arising from such claims. The IRS will only recognize such settlements as tax-deductible if they are the result of a lawful claim for damages. Therefore, if a victim of injuries at the fault of another party is unable to pursue legal remedies against the party at fault, it may be difficult for that party to satisfy the requirements for a lawsuit in order to retain the right to recover damages. As such, it is likely that the victim will be unable to retain any damages as a result of such settlements.
The third and final way in which such lawsuits are assessed to be taxable is by looking at the taxes that are ultimately generated as a result of such lawsuits. Although many of these cases ultimately result in a financial recovery for their victims and their attorneys, these claims often do not bring about large amounts of taxes. However, when these types of cases go to trial and a final settlement is reached, many victims of accidents and similar situations are able to receive substantial awards in court. Because these are typically tax-deductible, they do not attract the same deductions as standard non-taxable income. Thus, these types of settlement payments are generally assessed to be taxable income by the federal government.
In short, it is important to understand that if you anticipate claiming any tax-free settlement money from a court-awarded claim, it is extremely important that you consult with a certified public accountant before doing so. Such an accountant will be able to provide you with comprehensive information regarding the assessment of tax-free settlement money and will help you determine whether such monies are eligible for tax relief. Only an experienced and knowledgeable certified public accountant can ensure that your tax return is accurate and free of errors. To learn more about your rights in this area, contact a tax specialist today.
