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John Bair
John Bair
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Tax Considerations for Plaintiffs Who Obtain a Settlement

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Many questions arise when your personal injury lawsuit is about to end and you’re going receive a substantial monetary recovery. In addition to considerations about using the settlement proceeds now and in the future, paying taxes on this large amount of money can be of huge concern.

As a taxpayer, any monetary award you receive is considered taxable gross income. In cases in which settlement compensates a physical injury, sickness, or wrongful death, the Internal Revenue Code (IRC) allows plaintiffs to avoid paying taxes on the money when they initially receive it. This rule excludes punitive damages – meaning damages exceeding your compensation that are meant to punish the defendant for particularly outrageous behavior.

Controlling Taxes

settlement and taxesBefore receiving a settlement, plaintiffs have the option to roll the money into a traditional investment vehicle or financial institution; the proceeds received from the interest-bearing account are then taxable.

The IRC gives plaintiffs the option to invest in a tax-exempt holding account or a structured settlement. A structured settlement allows the injured party a means of deferring all or some of the settlement. Plaintiffs can then receive the proceeds when they know they’ll need it rather than all at once. Structuring a settlement can mean having the right amount of money allocated for immediate expenses, with the remainder provided as a series of guaranteed, tax-free payments to meet future needs. IRC §104(a)(2) states that 100 percent of every structured settlement payment you receive will be exempt from federal and state income tax.

Concerns for Family Members Receiving Some of a Settlement

If you’re a “derivative claimant,” meaning a family member who will receive a portion of an injured loved one’s settlement, you will not be required to pay taxes on the money when you initially receive it – just like the plaintiff isn’t required to do so. According to IRC §104(a)(2), if the claim originates from physical injury or sickness suffered by another person, then all settlement money (excluding punitive damages) is viewed as an award due to physical injury – whether or not the person receiving the settlement money is the injured party.

Taking the Right Steps to Protecting Your Settlement

Making the right choices about settlement proceeds can be overwhelming. At Milestone Consulting, our settlement planning experts consider each client’s individual situation, financial needs and objectives, and government compliance. As a planning-focused company, Milestone walks clients through the entire decision-making process so the plan is custom-tailored to their needs.

Although tax-exempt interest may seem attractive, each family’s situation should be reviewed thoroughly prior to implementing any settlement strategy. Contact Milestone today if you’re about to receive a settlement. We will ensure you have a role in planning for your future by giving you the knowledge of all available options. Together, we’ll develop your best course of action.

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