If the settlement agreement says nothing about whether the damages are taxable, the IRS will analyze the payer's intention to characterize the payments and determine the filing requirements of Form 1099. If you receive a taxable court settlement, you could receive Form 1099-MISC. The IRS DOES NOT pay personal injury settlement awards if these cases demonstrate “observable bodily harm.” Therefore, if the injuries are visible, the IRS considers the compensation money awarded for those injuries to be tax-free. Do not include these settlements in the income section of your tax forms. Before signing any settlement offer, make sure you understand the structure of the agreement and identify the parties that may be subject to tax.
When certain types of prizes are included in the offer, such as punitive damages, a poorly structured settlement can increase your tax liability and end up costing you thousands. Generally speaking, any settlement or judgment amount you receive as compensation for lost income is subject to income tax. The reasoning is that your original income would have been taxable if you hadn't suffered the loss of income, so any compensation intended to replace that same loss of income should also be taxable. The employer treats it as a payroll check, withholding applicable taxes, Social Security and Medicare (Federal Insurance Contributions Act (“FICA)” taxes).
Settlements and judgments are taxed according to the source of the claim, the nature of the damages for which the plaintiff was suing. If the agreement is taxable income other than the employee's salary, the payment will be reported on a Form 1099-MISC. Any interest on settlement payments will also be included in gross income, because it has no relation to the underlying physical injury or physical illness. It's no surprise, therefore, that when it comes to surrogacy agreements and settlement check disbursement, there is no uniform set of procedures to follow, and lawyers, surrogacy professionals, and claims professionals are left scratching their heads.
For example, if one lawsuit is related to personal injury and the other is a non-personal injury claim, one settlement is excluded from taxes and the other is not. Knowing the most common types of compensation awarded in personal injury lawsuits and how settlements are taxed will help you understand if which part, if any, of your personal injury settlement is taxable. Federal tax rules and resources within the CCH Standard Federal Tax Reporter exceed 75,000 pages, enough to fill a small library. If you have questions about tax liability for personal injury settlements, or if compensatory or punitive damages are taxable, Raphaelson & Levine Law Firm can help.
If the settlement agreement is explicit and denies a Form 1099, you can say that Form 1099 violates the settlement agreement. There is also post-trial interest, which accumulates between the judgment and the time the settlement is actually paid. If the agreement is with the plaintiff's employer and includes lost wages, the employer paying the settlement must report the payment on a Form W-2 and withhold applicable income taxes and Social Security taxes. Often, a plaintiff is also required to file a Form W-9 when a lawsuit is resolved to allow the liability company to properly report settlement payment to the I.
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