Tax rules vary on lawsuit cash settlements

I will receive a cash settlement from a wrongful-death lawsuit for between $50,000 and $100,000. Is this taxable or reportable income?

You should consult a tax accountant about your specific situation. A cash settlement can include compensation for several types of injury, each governed by different tax rules.

Damages awarded for a physical injury generally aren’t taxable — and a wrongful death settlement is compensation for a physical injury or illness that resulted in death. You don’t owe taxes on the portion of a wrongful death settlement that compensates you for economic losses like medical expenses, funeral costs and loss of earnings.

Damages for emotional distress suffered as a result of physical injury or physical illness are also generally tax-free. But if you’ve previously taken an itemized deduction for expenses relating to any of these injuries — like the cost of psychiatric care for emotional distress, for example — you must report and pay taxes on the amount you deducted to the extent that it provided a tax benefit.

Punitive damages generally are taxable. They aren’t intended as compensation for your loss, but to punish the person who caused your injury. You should report punitive damages on Form 1040 as “Other Income.”

Damages awarded for nonphysical injuries like fraud or breach of contract, unlawful discrimination, or wrongful termination are taxable as ordinary income. Settlements for the emotional distress caused by nonphysical injuries are also taxable. But you can reduce the taxable amount of the settlement for such distress by the medical expenses, if you haven’t previously deducted them, or if you deducted them but received no tax benefit for the deduction.

THE BOTTOM LINE

The tax treatment of a settlement depends on the injuries for which you’re being compensated.

MORE INFORMATION

• nwsdy.li/TaxableNontaxable
• nwsdy.li/Settlements