Anytime that there is potential for a cash settlement you should also prepare to consider the tax consequences. Litigation can be stressful and taxes are often the last thing on tour mind. But there are a few important tips to keep in mind.
Type of Recovery and Why it Matters - You may recover money for physical injuries or for non-physical injuries such as lost wages, emotional or punitive damages. You may receive compensation for both types of injuries in a personal injury case. A civil rights case will generally not include compensation for physical injury. Generally, recoveries for physical harm are not taxable. Other types of monetary settlements are taxable.
Your Attorney’s Role - There are two potential areas where you will need to make choices:
- May be possible to negotiate the taxable percentage of a settlement
If you have suffered both physical and non-physical injuries. Your attorney should ask you about your tax situation and take that into consideration.
- In general, legal fees incurred in a lawsuit (that results in income) can be deducted.
Consult the Internal Revenue Services (IRS) website for more information on this deduction.
- If the reward is large, the alternative minimum tax (AMT) may apply
The AMT is a section of the tax code most people do not generally need to consider. It was created to disallow certain deductions for people with high incomes. If you receive a very large sum as income, legal fees may not be deductible
The problem created by AMT and attorney fees
You may receive a lot less than you expect once the AMT and attorneys fees are deducted.
Tips for Consumers
- Make sure you talk to your attorney about tax consequences.
- Find out if your attorney is an expert in tax law.
- Consider hiring a tax attorney or tax specialist to review any potential settlement offer.