Settlement Agreement Income Taxable: What You Need to Know
A settlement agreement is a legal document that outlines the terms and conditions of a settlement of a lawsuit or dispute. Settlement agreements are common in employment law, personal injury cases, and other legal disputes.
If you receive a settlement payment, you may be wondering whether that income is taxable. The answer is that it depends on the type of settlement payment you receive.
Types of Settlement Payments
There are two types of settlement payments: compensatory and punitive.
Compensatory payments are payments that are meant to compensate you for a loss. For example, if you were involved in an employment dispute and received a settlement payment for lost wages, that payment would be considered compensatory.
Punitive payments are payments that are meant to punish the party who caused the harm. For example, if you were injured in a car accident and received a settlement payment that included punitive damages, that payment would be considered punitive.
Taxable vs. Non-Taxable Settlement Payments
Compensatory payments are generally taxable as income, while punitive payments are generally non-taxable.
However, there are some exceptions to this rule. If you receive a compensatory payment for a physical injury or illness, that payment may be non-taxable. Similarly, if you receive a compensatory payment for emotional distress resulting from a physical injury or illness, that payment may also be non-taxable.
It`s important to note that if you receive a settlement payment that includes both compensatory and punitive damages, you may need to allocate the payment between the two types of damages and report only the compensatory portion as income.
Reporting Settlement Payments on Your Tax Return
If you receive a settlement payment that is taxable, you will need to report it on your tax return. The payment should be reported as income on your tax return in the year you receive it, even if the settlement agreement covers multiple years.
You will receive a Form 1099 from the party issuing the settlement payment, which will show the amount of the payment and whether any taxes were withheld. Make sure to include the amount of the payment on your tax return and pay any additional taxes owed.
In some cases, you may be able to deduct the amount of legal fees you incurred in connection with the settlement payment. However, the rules around deducting legal fees can be complex, so it`s important to consult with a tax professional.
In conclusion, settlement agreement income is generally taxable as income, but there are exceptions for compensatory payments related to physical injuries or illnesses. If you receive a settlement payment, make sure to report it on your tax return and pay any taxes owed. Consult with a tax professional if you have questions about the tax implications of your settlement agreement.