When you receive a lawsuit settlement in Nevada, you must understand the tax implications. Lawsuit settlements can have a big influence on your financial condition, and understanding how to reduce tax liability might help you keep more of your decision-making. This article outlines the options you can use to lessen the tax burden on your settlement.

Understanding Taxable and Non-Taxable Settlements

Lawsuit settlements might be classified as taxable or non-taxable, determining how much of your settlement you can keep. In general, personal injury settlements are not taxed. According to the Internal Revenue Service (IRS), if you obtain a settlement for personal physical injuries or illness, the money is usually deducted from your gross income and thus not taxable.

However, not all settlement components are tax deductible. For example, payments for emotional distress or punitive damages are usually taxable. The IRS distinguishes between physical injuries and emotional distress: if the emotional distress comes from a physical injury, it may not be taxable; if it is unrelated to any physical injury, it usually is.

Factors Affecting Lawsuit Settlements

Internal Revenue Code Section 61 states that all payments from any source are considered gross income unless a specified exemption applies. When you win a settlement, it might be difficult to determine whether your reward is taxable without examining the specifics. This list focuses on eight common elements that affect taxability.

• Physical injury or sickness: Settlements for physical injury or sickness if you have shown “observable bodily harm” are not taxable under the IRS.
• Emotional distress may be taxable: You must pay taxes on emotional distress awards unless an accident-related injury or illness causes the distress.
• Medical Expenses: Awards for medical expenses are not taxable if you did not deduct associated medical bills from your previous year’s taxes. If you deducted them last year, you’ll owe taxes on the amount this year under the IRS’s “tax benefit rule.”
• Punitive damages are taxable: Some judgments and settlements include awarding punitive damages against the defendant. These damages can result in a large compensation for the plaintiff. The total punitive damages award is taxable, which might result in significant taxes.
• Contingency fees may be taxable: Legal expenses will not impact your taxable income if your settlement is not taxable. Accident and personal injury cases, such as a slip-and-fall or worker’s compensation claim, are excluded.
• Capital gains rather than ordinary income: Depending on the nature of your claim, you may be entitled to consider some of the settlement as capital gains. If you sued for damage to your house or business factory, you may be entitled to claim the settlement as capital gains.
• Spread payments over time to avoid paying more taxes: Receiving a significant taxable settlement can push your income into higher tax categories. Spreading your settlement payments over numerous years allows you to lower the income exposed to the highest tax rates.

How to Minimize Tax Liability on Lawsuit Settlements?

1. Use Settlement Funds wisely

One successful technique for reducing tax liability is to distribute settlement funds strategically. This involves categorizing the settlement and prioritizing non-taxable components. For example, designating a more significant share of the settlement to physical injuries or sickness can increase the non-taxable amount.

For example, if you obtain a $100,000 settlement, you may allocate $60,000 for non-taxable physical injuries and $40,000 for taxable emotional distress. You can lower the taxable portion of your payout by correctly stating these allocations in the settlement agreement.

2. Structured settlements.

Another way to avoid tax liabilities is to use a structured settlement rather than a lump sum payout. Structured settlements allow you to receive your settlement in installments over time. This can assist you avoid being pushed into a higher tax bracket because your income is spread out.

Benefits:

• Tax Bracket Management: Receiving smaller sums over time allows you to better control your tax bracket and potentially pay less in taxes overall.
• Financial planning: Structured settlements offer a consistent revenue stream, aiding long-term financial planning.

3. Utilize the Plaintiff Recovery Trust

The Plaintiff Recovery Trust (PRT) is an innovative tool that enables plaintiffs to avoid double taxation on attorney fees. The IRS frequently considers the full settlement amount as taxable income, even if a portion is paid directly to your attorney as a contingency fee. This can result in a greater tax bill than expected.

Setting up a Plaintiff Recovery Trust before finalizing the settlement allows you to allocate funds specifically for attorney fees and lower the taxable amount in proportion. This approach takes careful planning and should be reviewed with a tax professional to ensure it is properly implemented.

4. Maximize the Medical Expense Exclusion

One frequently neglected method for plaintiffs to decrease their taxes is to designate or assign a portion of the settlement agreement to past and future medical expenses. 

Even if the legal claim is not based on personal bodily injuries or disease, plaintiffs may be eligible to use some settlement money for tax-free medical expenses. 

This method can cut taxes even in circumstances like:

• Emotional distress.
• Employment disputes. 
• Defamation 
• And many more issues.

For example, suppose an employee sues their company for race-based workplace discrimination, resulting in emotional distress. While emotional distress damages are normally taxable, the plaintiff could demonstrate medical expenses incurred as a result of physical conditions such as depression, insomnia, or anxiety.

5. Allocate All Damages in the Settlement Agreement.

In addition to designating a portion of the settlement for compensation of medical expenditures, allocating the settlement to different categories of damages might result in significant tax savings. 

A plaintiff may be entitled to claim a portion of the settlement money due to a personal physical injury, allowing them to receive those funds tax-free. The plaintiff may set aside a portion of the settlement to cover expenditures incurred due to the defendant’s wrongful behavior.

For example, if a plaintiff sues a financial advisor for providing incorrect investment advice, a portion of the settlement may be viewed as repayment of the lost investment principle. This part would not be taxed.

Speak to a Las Vegas Personal Injury Attorney Today!

Contacting a personal injury attorney is crucial if you’ve been injured and need to minimize tax liability on your lawsuit settlement. They can provide expert guidance and help you navigate complex tax implications. Moss Berg Injury Lawyers are well-equipped to handle your case and ensure you maximize your financial recovery while minimizing tax burdens. Contact us today for experienced legal support.