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John Bair
John Bair
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How Much of Your Settlement Will Go to the IRS?

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After the $7.8 billion settlement with BP for the Deepwater Horizon oil spill concluded, some plaintiffs found out too late that they had to pay taxes on their compensation. Because the lump sum of income pushed many of them into a higher tax bracket, those who did not establish a durable plan prior to settlement were left paying way more in taxes than they had ever paid before — and that’s on top of suffering losses including illness, injuries, economic loss, and property damage.

spreading taxes after settlementThis situation frequently happens when a plaintiff does not have adequate information about financial planning prior to settlement. That’s because as a taxpayer, any monetary award you receive is assumed to be gross income and is taxable. A settlement recovery that pushes claimants into higher tax brackets forces them to retain less of their recovery.

This rule does not apply to all types of cases. If your settlement is due to a physical injury, sickness, or wrongful death, for example, you will not need to pay tax on your settlement when you initially receive it. On the other hand, cases involving sexual harassment, discrimination, fraud, whistleblower situations, and intellectual property are taxable.

In a previous post, we answer the following questions about settlement and taxes:

  • Is the settlement I am about to receive taxable?
  • If I invest my settlement money, will it be taxed?
  • My family member has been injured and I will be receiving a portion of the settlement. Will I have to pay taxes on the settlement award?
  • Once I receive my settlement, what are my options?

If you’re approaching settlement, having this background knowledge is key. A comprehensive settlement planning firm can then explain your options.

Tax and Income Spreading

To ease what could be a staggering tax burden, plaintiffs may take settlement payments out over time as opposed to accepting a lump sum. Doing so reduces their taxes by remaining below the threshold for many deductions, credits and/or allowances that phase out with increased income. This method of “spreading taxes” is also referred to as deferred compensation or income spreading.

Because the settlement process is voluntary, this one-time tax planning opportunity is part of the resolution of a claim and must be made prior to settlement. As a plaintiff, the sooner you speak with a settlement planning expert, the sooner you’ll have peace of mind that you’ll get to keep as much of your settlement recovery as possible and reap the benefits of it long into the future.

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