April 15 is right around the corner, which probably has most of us thinking about taxes. But for plaintiffs going through the stress of litigation, it might be the last thing on their minds right now. Sooner or later though, the thought will land like a ton of bricks: Will I have to pay taxes on my settlement?
Depending on the type of case, there may or may not be a tax obligation on that settlement money. Personal injury lawsuits are considered “qualified,” which means they generally are not taxable. More specifically, the Internal Revenue Code states that a person’s gross income does not include damages received in a lawsuit over personal physical injuries or illness (aside from punitive damages). But IRC § 104(a)(2) notes that in cases of non-physical injury, “amounts excludable for emotional distress are limited to actual ‘out of pocket’ medical costs.” In other words, monetary awards from lawsuits that do not involve bodily injury ARE taxable. It’s an unfortunate drawback to the conclusion of lawsuits involving sexual harassment, discrimination, whistleblowers, fraud, intellectual property, and others that do not involve physical injury. Without proper planning, non-qualified settlement money can come with a big price tag from the IRS the following tax season – which means less compensation for the plaintiff and possibly a higher tax bracket. With some strategic planning, however, those plaintiffs can lighten their tax burden each year.
How a non-qualified assignment can help
When litigating non-injury cases, attorneys sometimes work with an expert settlement planner to establish a non-qualified assignment, or NQA. An NQA is an assignment of an obligation to pay money in the future (also known as a structured plan) in cases that do not involve bodily injury. An NQA allows plaintiffs and their attorneys to spread settlement income over future years. In this regard, it does what a structured settlement does for plaintiffs with personal injury cases.
A non-qualified assignment allows a plaintiff to choose an investment-backed structure or other type of structured plan to receive his or her settlement in smaller increments instead of in a lump sum. He or she would only be responsible for paying taxes on the payments received each year, rather than paying taxes on the whole settlement at once. In addition to the tax advantages, choosing to receive the settlement in increments allows for stronger, more long-term-focused financial planning, which can be extremely beneficial to an individual with a large incoming settlement.
If you’re concerned about getting taxed on your settlement, congratulations – that means you’re looking toward justice and compensation in your case. But now is the time to act quickly to avoid one massive tax bite. Using planning tools like a non-qualified assignment, you can control the timing of your payments and taxation. Feel free to call us to discuss it further.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).