Plaintiffs who are approaching settlement in certain cases may find an unexpected drawback at the conclusion of their lawsuit: the money they receive is taxable. At the following tax season, their settlement will come with a big price tag for the IRS, which means less compensation for them. Fortunately, with some strategic planning, those plaintiffs can lighten the tax burden. But they must act quickly.
In general, 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, such as discrimination, fraud, etc., 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, which can result in a major financial blow to the plaintiff. These taxable lawsuits may involve issues including (but not limited to):
- Sexual harassment
- Patents and intellectual property
Without proper planning, a plaintiff could pay thousands of dollars to the IRS after receiving his or her settlement.
The Solution for Many Plaintiffs: A Non-qualified Assignment
To avoid the tax hit on a non-personal injury award, many individuals work with a comprehensive settlement planner to establish a non-qualified assignment (NQA). An NQA is a structured plan — also known as an assignment or an obligation — to make future payments to the plaintiff using portions from non-injury settlement money. A plaintiff who establishes an NQA would receive these payments over time instead of receiving a lump sum settlement. He or she would then be responsible for paying taxes on the payments received in a given year, rather than the whole settlement at once.
There are two main benefits of an NQA for a plaintiff:
- An opportunity to spread the tax burden over time rather than all at once
- Control over the timing and amount of income provided from the settlement each year
Milestone Consulting is one of the only companies currently offering an independent, non-qualified solution that allows plaintiffs to evaluate the amount of the settlement they take when their settlement arrives. They are then able to defer portions of the settlement through non-qualified assignments to reduce the overall tax hit and provide pre-tax investment options.
If you’re concerned about getting taxed on your non-personal injury settlement, congratulations — that means your case is ending and you’re looking toward justice and compensation. But now is the time to act quickly to avoid the tax bite. Through the use of planning tools like a non-qualified assignments, you can control the timing of your payments and thus your taxation. We welcome you to call Milestone for more information.
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).