This post is the first in a series titled “Taxable Settlements 101,” which looks at some notable cases in which plaintiffs were taxed on their settlement recovery. This post also offers insight into how plaintiffs can prevent reaching a higher tax bracket after settlement — and suffering the taxable burden as a result.
The Deepwater Horizon oil spill began on April 20, 2010 on the BP-operated Macondo Prospect in the Gulf of Mexico. Eleven people were killed, and the U.S. government estimated the total oil discharge at 210 million gallons.
The people impacted by the Deepwater Horizon oil spill brought claims against BP after suffering various devastating losses including illness, injuries, economic loss, and property damage. In 2012, they reached a multimillion-dollar settlement with BP. Unfortunately, plaintiffs who obtained a settlement recovery may not have realized that some of their compensation would go to the IRS. Many of those who did not establish a durable plan for their settlement were left paying way more in taxes than they had ever paid before.
Why did it happen? In short, the BP oil spill settlement was considered a “taxable settlement.” Not all lawsuit recoveries are taxable; for example, in most personal injury claims, states and the IRS cannot tax plaintiffs on settlement or verdict proceeds. The settlement recovery was taxable for plaintiffs in the BP litigation, however, and it had the potential to push them into a higher tax bracket — unless they planned accordingly. Come tax season, claimants without an appropriate financial plan had to pay more to the IRS.
What Can Plaintiffs Do to Avoid a Higher Tax Bracket?
Prior to settlement, plaintiffs can elect to receive settlement payments over time instead of accepting a lump sum of money at once. Doing so may allow them to do the following:
- Remain below the threshold of a higher tax bracket,
- Pay less in taxes, and
- Avoid losing the many deductions, credits and allowances that phase out with increased income.
This method of “spreading taxes” is also referred to as deferred compensation or income spreading, which in essence lowers the individual plaintiff’s annual taxable income. The process involves a one-time setup with a settlement planner to ensure compliance with the procedure outlined by the court involved in the litigation.
Tax planning is a foundation for wealth management. Business executives and others who earn substantial income use wealth management strategies to lower their taxable income. These people benefit from the knowledge of their experienced financial planners, but getting expert wealth management advice is not exclusively intended for the wealthy. Plaintiffs should do the same as settlement approaches to protect themselves and ensure their settlement is as beneficial as possible. Working closely with a comprehensive settlement planner will allow claimants to carefully review their options for income spreading over a few years.
Spreading taxes by negotiating a custom-tailored payout strategy is what settlement planning is all about. If you’re a plaintiff in litigation, Milestone Consulting can help you establish a personalized plan for your recovery.
About John Bair
John Bair has guided thousands of plaintiffs through the settlement process as co-founder of Milestone Consulting, LLC, a broad-based settlement planning and management firm. Milestone’s approach is comprehensive and future-focused. John’s team has guided thousands of clients by taking the time to understand the complexities of each case. They assess the best outcome and find the path that enables each client to manage their many needs. Read more about Milestone Consulting at http://milestoneseventh.com/.
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).