It's always thrilling to receive a little financial windfall. Extra money is always good even when you're owed the sum due to another person's negligence or bad intent.
Your first thought may concern what you'll buy with your small fortune, but your second thought will normally be, "Will I owe taxes on this money?"
Here's the tax lowdown for two types of unlucky windfalls:
Car Insurance Settlement
Any vehicle accident settlements that pay you back for actual costs, including amounts paid for medical care, are generally not taxable. If the guilty party is paying money as punishment for causing you harm, that settlement is probably taxable.
If you receive a check from an insurance company or an individual that represents the replacement cost for your vehicle, you won't be taxed on that amount. If you make a profit from any settlement paid for your vehicle, you will owe taxes on the profit. If your claim includes damages for future loss of income, you'll also owe taxes on that amount.
Always consult a knowledgeable tax attorney (such as LaSpada, Anthony J. PA) before accepting any car accident settlement to understand how the funds will affect your state and federal tax liability. Don't be afraid to negotiate for a larger settlement if taxes will eat away at an award you need to cover expenses while you recover.
Workers Compensation Settlement
A workers comp settlement is treated much the same as any insurance payout. Money you receive for actual bills you'll pay, or for expenses you've already paid, should be considered free and clear of tax liability. The rules can be confusing, though, since physical and emotional suffering can be connected or separated as far as compensating a victim goes. You might receive a lump sum to cover future therapy, for which you'll owe no taxes, while also being awarded a punitive settlement amount for your pain and suffering, for which you'll be taxed.
If your employer is ordered to pay out a settlement to you, they may be required to withhold state and federal taxes from your total awarded amount before you receive your judgment. A recent appellate court ruling claims that this type of tax withholding is appropriate.
Other settlement amounts will depend on what the money is meant to cover. Is it a judgment intended to slap the guilty party on the wrist for their negligence? A small sum meant to cover all the wages you've lost? Each separate kind of settlement is considered a specific kind of payment, whether it's called compensation, income, or damages, so make certain a tax attorney reviews any workers compensation settlement before you sign it.
You need to know how much you'll owe the IRS and your state before you decide that the cash you're being offered in a settlement is enough to cover all of your losses. A competent tax lawyer will be able to provide you with that information.
