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Tax treatment of monetary settlements requires careful review

Each year, a certain number of Oregon residents suffer injuries in accidents caused by other people, while others endure harassment, discrimination or retaliation at work. When these individuals exercise their rights to make claims for such incidents, they may receive monetary awards. Not everyone remembers that he or she may be on the hook for income taxes on these monetary settlements.

If you received some sort of monetary settlement this year, or expect to before Dec. 31, then you may want to gain an understanding of what you can expect at tax time.

The "origin of the claim" doctrine

How the IRS treats your settlement depends on what type of claim you filed. If the money compensates you for lost profits, lost income or other employment damages, you will more than likely pay taxes on it as income. If the money you receive represents a return for capital injured or destroyed, you probably won't owe taxes on it as income as long as it does not exceed the value of the original property. When it comes to awards for physical injuries, it depends on the type. Consider the following:

  • The IRS does not count monies for observable injuries such as swelling, bleeding, cuts and bruises as income.
  • Even though emotional distress results in physical symptoms such as stomach disorders, insomnia or headaches, the IRS does not exclude it as income, except under certain circumstances.
  • Emotional distress attributed to a physical illness or injury may not count as income.
  • Money for medical expenses related to emotional distress might be an exclusion as income under certain circumstances.
  • You will probably pay taxes on the full amount of a taxable award even if you owe attorney's fees.

When it comes to a settlement related to employment, your employer will more than likely deduct all of the normal employment taxes unless the award was for lost income related to qualifying physical injuries.

Every case is different

Many people end up in trouble when it comes to settlements because they fail to consider the taxes. They end up owing the IRS thousands, if not tens of thousands of dollars or more, that they cannot pay because they spent the monies they received. If you received, or anticipate receiving, a monetary settlement, you may want to gain a thorough understanding of its tax implications. This will help you avoid owing a large sum of money to the IRS and prepare for the amount of money you will actually have to spend.

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