July 26, 2015

Tax: Are Lawsuit Settlements/Judgments Taxable/Deductible?

For the Defendant to the lawsuit, the answer to this question is, it depends. If the Defendant is a business, then the answer is more straightforward, as nearly all lawsuit/litigation costs are deductible as a business expense (including payment of court fees, attorney's fees and payment of the settlement/judgment). When the Defendant is an individual, the rules as to what is deductible on the Defendant's tax return vary greatly, depending upon the type of case and other factors.

For the Plaintiff to the lawsuit, the answer to this question is also, it depends. When the Plaintiff recovers money from the Defendant, by way of settlement/judgment, it is important to identify what "type of damage" is being paid to the Plaintiff. If the damage being paid is a "punitive damage," which is a damage meant to punish the Defendant for the Defendant's behavior, the Plaintiff will always have to pay income tax on the money received. The same is also true when the Plaintiff collects a settlement/judgment where the Defendant is forced to pay the Plaintiff interest on the settlement/judgment and when the Defendant, typically in a workplace lawsuit, pays the Plaintiff money to compensate the Plaintiff for lost wages when the Plaintiff did not suffer physical harm in relation to the lawsuit. The Defendant's payment to the Plaintiff for other damages, however, are not taxable, such as damages paid to compensate the Plaintiff for pain and suffering.

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