Understanding Tax Treatment of Settlement Awards
Getting the right tax advice is vital in the complex tax world we live in. iBestTravel helps you navigate through the latest news and forecasts, offering insights from our highly experienced team.
Tax Implications of Damage or Settlement Awards
It’s important to remember that proceeds received for physical injuries or physical illnesses are generally tax-free. During an audit, IRS agents will typically examine the court petition, complaint, or claim filed. They will review the settlement agreement to ascertain how the document characterizes the amounts paid and received by the involved parties.
Emotional Distress Settlements
Conversely, damages received for emotional distress are usually taxable, with two notable exceptions:
- Amounts paid for mental anguish related to physical injuries are tax-free.
- Reimbursements for medical treatments addressing emotional trauma are also exempt from tax.
Employment Dispute Settlement Awards
Payments received as part of settling an employment dispute are deemed taxable income. For example, a man who filed a lawsuit for wrongful termination received approximately $70,000 following a settlement, most of which was attributed to emotional distress and relocation assistance. According to findings from the U.S. Tax Court, despite claims of physical and mental health injuries caused by his work, the court determined that the settlement proceeds were primarily compensation for settling the employment dispute (Keenan, TC Bench Opinion).
Conclusion
Understanding the tax implications surrounding settlement awards and damages is crucial for effective financial planning. Keep informed to avoid any unforeseen tax liabilities, and always consult with tax professionals for personalized advice.
