The purpose of most lawsuits is to make a plaintiff whole after an injury or other loss. Settling a lawsuit might bring the litigation to a close, but the plaintiff must still contend with the IRS. Luckily, taxation of lawsuit settlements is fairly straightforward once one understands a few principles that our Los Angeles tax advisors can explain.
Settling a Lawsuit vs. Winning a Verdict or Judgment
The IRS makes no distinction between a payment received due to a settlement and one that comes after a jury verdict or court order. In either case, a taxpayer receives compensation for one or more legal claims. We will use the term “settlement” for the sake of brevity, but the same principles apply to damage awards.
One advantage of a verdict or court order is that it is more likely to contain a breakdown of damages. Verdicts often specify the amounts awarded for different claims. This can help a plaintiff when they are preparing their taxes. For this reason, it is often advisable to include a written allocation of damages in a settlement agreement.