Structured settlements and lump-sum payments for compensatory damages in personal injury cases are tax-exempt, meaning there is no different tax advantage for the type of settlement payment you receive. In some cases, a tax provision in the settlement agreement that characterizes the payment may result in its exclusion from taxable income. The IRS will analyze the payer's intention to characterize the payments and determine the reporting requirements of Form 1099. If you have won a lawsuit and will soon receive a large amount of damages, you may be wondering if you have to pay taxes for this money. Unfortunately, the only damages you can enjoy tax-free are those that compensate you for physical injury or physical illness.
Awards and agreements can be divided into two distinct groups to determine whether payments are taxable or non-taxable. Under federal Internal Revenue Code Section 104 (a), damages paid due to physical injury or wrongful death are excluded from a person's income tax. However, any settlement or judgment amount you receive as compensation for loss of income is subject to income tax. The long-term disability agreement will generally be tax-free if you paid the premium with money that had already been taxed (such as taxable income).Punitive damages, which are intended to punish the defendant, are almost always taxable. If you must pay taxes in your lump-sum settlement, you can end up having negative tax consequences because you would pay taxes at a higher rate than if you received compensation over time. To shed more light on this bleak forecast, we recommend talking to a tax professional.
Discuss your situation with an attorney serving your state for specific legal guidance on paying taxes while receiving workers' compensation benefits. Interviewing the taxpayer to determine if the taxpayer provided any type of settlement payment to any of their employees (past or present) is also important. The Supreme Court holds that the amount received in resolving a claim for late payment and liquidated damages under the Age Discrimination in Employment Act does not qualify for §104 (a) (exclusion). If you receive a one-time payment for money that you would be entitled to if the defendant hadn't done it wrong, you could suddenly find yourself in a higher tax bracket. Under Section 104 (a), late payment received to satisfy such a claim was not excludable from gross income, but damages received for emotional distress are excludable. However, keep in mind that you probably owe federal income taxes on the agreement for the year you received it. There are several elements to consider when deciding if a long-term disability lump-sum agreement is right for you.
Postpone that trip to Los Cabos and talk to a tax professional before making any decisions.