What would you do if you had an extra $75,000 tacked onto your income in 2021? At first, it might seem like a blessing. Come tax time, though, it might feel more like a curse.
The average lawsuit settlement hovers around $3,000-$75,000. But, is a lawsuit settlement taxable? If so, you need to know how to prepare your finances. Read on to get informed and learn what to do if you have a settlement coming your way.
Is a Lawsuit Settlement Taxable?
Did you know that the IRS defines your gross income as all money from whatever source derived? That means almost every sum you earn is taxable, including a lawsuit settlement.
In general, you should expect your settlement to get taxed. You’ll need to document the money you receive as “income” in the year you receive it. This includes compensation in the form of lost wages and punitive damages.
There is a specific exception to this rule, though. Learn what types of settlements aren’t taxed below.
Non-Taxable Settlements
The IRS will not tax any settlement from lawsuits involving bodily harm. That means if injuries are physical and visible, then the settlement award won’t get taxed.
As a general rule, that means the following types of settlements are tax-free:
- Personal injury lawsuits
- Car accident injury settlements
- Attorney contingency fees
- Medical fees related to emotional distress (if you haven’t deducted them before)
- Emotional distress settlements
It’s complicated to determine which settlements get taxed and which ones don’t. If you have more questions, it’s a good idea to consult with a finance expert or attorney.
What Settlement Payout Options Do I Have?
So, will you have to pay taxes on lawsuit settlement earnings? In a nutshell, it depends on whether you suffered an injury or not. It also makes a difference what type of damages you’re receiving.
You do have different settlement payout options, though. These options can potentially help you save money on your taxes, so you’ll want to make an informed choice. Here are the most common types of payouts you can get:
- Lump sum payments
- Structured settlement (long-term payments)
- Pre-settlement funding
The process of pre-settlement funding gives you instant access to your cash. A lump sum payment does, too. Both of these payments would have a bigger tax implication than long-term plans.
Getting a Settlement Isn’t All Gravy
A lot of people have the misconception that they can make bank off of a lawsuit. Getting a massive settlement amount isn’t all gravy, though. In reality, most of any money you get will go straight towards paying off your debts.
You may wonder — is a lawsuit settlement taxable? Often, it is. That means a big settlement could push you into a higher tax bracket! You need to consider these important facts before you make plans for your settlement money.
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