Such agreements aren’t binding on the IRS or the courts in later tax disputes, but they are usually not ignored by the IRS.Ĥ. It is best for plaintiff and defendant to agree on tax treatment. Even if your dispute relates to one course of conduct, there’s a good chance the total settlement involves several types of consideration. You might claim that the defendant kept your laptop, frittered away your trust fund, underpaid you, failed to reimburse you for a business trip, or other items. Allocating damages can save taxes. Most legal disputes involve multiple issues. Haggling over tax details before you sign and settle is best.ģ. If in an employment dispute you receive $50,000 extra because your employer gave you an ulcer, is an ulcer physical, or merely a symptom of emotional distress? Many plaintiffs take aggressive positions on their tax returns, but that can be a losing battle if the defendant issues an IRS Form 1099 for the entire settlement. Physical symptoms of emotional distress (like headaches and stomachaches) is taxed, but physical injuries or sickness is not. The rules can make some tax cases chicken or egg, with many judgment calls. But since 1996, your injury must be “physical.” If you sue for intentional infliction of emotional distress, your recovery is taxed. Before 1996, all “personal” damages were tax-free, so emotional distress and defamation produced tax-free recoveries. Recoveries for physical injuries and physical sickness are tax-free, but symptoms of emotional distress are not physical. If you sue for physical injuries, damages are tax-free. The rules are full of exceptions and nuances, so be careful, how settlement awards are taxed, especially post-tax reform.Ģ. If you get laid off at work and sue seeking wages, you’ll be taxed as wages, and probably some pay on a Form 1099 for emotional distress. But if you sue for damage to your condo by a negligent building contractor, your damages may not be income. You may be able to treat the recovery as a reduction in your purchase price of the condo. Taxes depend on the “origin of the claim.” Taxes are based on the origin of your claim.
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