How Is A Lawsuit Settlement Taxed?

The settlement is to compensate for his personal physical injuries and so would not be taxable.

If somehow the settlement specifies he shared in the fault, this could change things, but I seriously doubt there is any such statement.

In general, punitive damages are taxable as Other Income. But in wrongful death, they may be not taxable as well.

BEGIN QUOTE IRC 104

(a) In general Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include?

...

(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

[ie. punitive damages are included in gross income]

... ... ...

The phrase ?(other than punitive damages)? shall not apply to punitive damages awarded in a civil action? (1) which is a wrongful death action, and (2) with respect to which applicable State law (as in effect on September 13,

1995 and without regard to any modification after such date) provides, or has been construed to provide by a court of competent jurisdiction pursuant to a decision issued on or before September 13, 1995, that only punitive damages may be awarded in such an action. This subsection shall cease to apply to any civil action filed on or after the first date on which the applicable State law ceases to provide (or is no longer construed to provide) the treatment described in paragraph (2).

END QUOTE

I'm not quite sure what paragraph (2) above means, but somehow the state law has to require that punitive damages must be paid, then the whole thing is not taxable in the case of death.

There is also a right and a not so right way to do things with respect to the attorney fees, so they are properly deductible, or come off the top. Anyone here know the details?

If the damage award is for personal injuries, it is not taxable. So attorneys fees spent to get it are not deductible, because there's no taxable income to deduct it from

If the damage award is taxable, the attorneys fees are likely not deductible unless it can be characterized as for business.

___ Stu

Attorneys' fees for taxable non-business damages are deducted on Schedule A as miscellaneous itemized deductions subject to the 2% of adjusted gross income reduction.

My wife says it is wrongful death. Does "may not be taxable" mean it depends? The lawyer gets 1/3 of the settlement rather than fees.

Thanks, Gary

attorney's fees (his/her share is his/her fee) is not deductible.

Just to clarify, the code does not allow amounts for emotional damages to be tax-free. In addition, the code says that if the state requires damages to be paid in the case of a wrongful death, even those damages are not taxable -- but this is only to the case of wrongful death.

Some attorney fees are an above-the-line deduction. These are for unlawful discrimination, whistle-blowers, and a 2 other specific cases. See IRC 62, sections 20 and 21.

be tax-free. In addition, the code says that if the state requires damages to be paid in the case of a wrongful death, even those damages are not taxable -- but this is only to the case of wrongful death.

Further clarification: The CURRENT code. Before the change in 1996, emotional damages tied to a personal injury were not taxed (as long as the other requirements of the section were met). Only punitive damages were taxable (under the old law).

unlawful discrimination, whistle-blowers, and a 2 other specific cases. See IRC 62, sections 20 and 21.

I believe you are mistaken. Compensation for emotional damage tied to physical injury or illness continues to be excludable. Besides punative damages, compensation for medical costs that have already been deducted are also taxable (the taxable amount is computed using the tax benefit rule).

Yes, that is a good point. My main point is that attorney's fees generated for taxable damage settlements are deductible whether the injury was business related or not.

Here is support for my assertion.

**BEGIN QUOTE** Regulation, §1.104-1 (c)Damages received on account of personal physical injuries or physical sickness

(1)In general.? Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress. For purposes of this paragraph (c), the term damages means an amount received (other than workers' compensation) through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of prosecution.

**END QUOTE**

In particular, the third full sentence states, "However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2)."

Also, these new regs no longer require that a settlement be based on a tort or tort like action to be excludable.

Emotional damage is NOT a physical injury and as of 1996, no longer qualifies for exclusion -- especially if tied to those personal injuries which are NOT themselves physical.

...Or prorated.

What part of Regulation §1.104-1 do you not understand?

And, who, besides you, has said anything about emotional damage tied to a non-physical personal injury?

Certainly NOT you.

Emotional damages by themselves ARE taxable. That was my point.

It has been a long journey but you're almost there.

You started out by saying, "Emotional damage is NOT a physical injury and as of 1996, no longer qualifies for exclusion."

Now you say, "Emotional damages by themselves ARE taxable."

Now just one more tiny step. Say, "Compensation for emotional damage related to a physical injury or illness is excluded from federal taxable income." Go ahead. Say it. You know you want to.

You continuously and completely missed the point: My response was to warn that emotional damages NOT part of a physical injury IS taxable.

Re-read the post that I responded to. I was talking about the CHANGE in

1996, where non-physical injury damages were reclassifed from non-taxable to taxable.

Apr 11, 6:02 pm, "D. Stussy"

All I can suggest is that you be more clear when you are making posts that are not directly responsive to the question in the OP.

"D. Stussy"

Who is to decide whether and how much of the emotional damages are taxable? Say you received 15k for physical damages and 100k for emotional damages. How much of that 100k is tax-free?

Unlikely scenario. But if that's the case, then all the emotional damages that are part of the personal physical injury damages would be nontaxable.