What taxes need to be paid on a lawsuit settlement?

Question

I need to come up with a figure regarding a settlement with an insurance company because of a permanent debilitating injury to myself. The question is about how much I should expect to pay in taxes. (If it matters, I live in the state of Pennsylvania, in Pittsburgh.)

If I am looking to have somewhere between $1 and $5million in my pocket (well, bank) after the lawyer gets 40%, what should I take into consideration for taxes? Are taxes paid before or after the lawyer?

What I'm looking for is pretty much "If you get $1 million, they would have to pay x, if you get $5 million, they would have to pay y, etc."

Also, if you know anything about the subject, please let me know if you think that I'm asking for too much or too little. Pretty much I'm early 20s and this has ruined the rest of my life, I am in constant pain, need help to live, and am out of treatment options.

Thank you all so much! I know nothing and need help!

Answer 1

You may be able to avoid paying any taxes on the settlement. We have a client who had a settlement for injuries suffered in a automobile accident, and has lingering medical issues. We have said that his settlement is being held aside to pay for future medical issues. The client isn't being taxed on the settlement, but also can't deduct any medical expenses related to the accident, until the settlement amount is totally used up. His settlement though was nowhere near your amount. To bolster your case I would ask your doctor how much does he/she think that your future medical bills will be, and set that amount aside to pay for future medical expenses. Check out Revenue Ruling 75-232, 1975-1 CB 94, IRC Section 213.

Don't know how Pennsylvania would work in regards to this though, TaxMan would be the better person to ask with the state issue than I would.

Answer 2

Sorry about your injury - that's a lousy thing to happen. And if it's permanent, especially if it will prevent you from working, you aren't asking too much at all. Ending up with $1 million actually sounds on the light side. Of course it depends who is being sued - if it's a regular person, and their insurance cap is say $1 million, then you aren't likely to actually get much more than that no matter what the judge says.

If there's any bright spot here at all, it's in the tax area - there won't be federal tax on it since it's for a physical injury, and PA doesn't tax insurance settlements, so at least, after the lawyer's cut, you'll get to keep what you get.

I hope you have a really good lawyer, and that the judge and/or jury realizes what this has done to you and compensates you fairly. Good luck.

Answer 3

Settlements for physical injury or illness are not taxed.

If any portion if earmarked for lost wages, interest on the settlement or punitive damages then those portions are taxed as ordinary income.

There can be an exception to the punitive damages treatment if your state's laws do not allow punitive damages. In that case, anything referred to in the settlement as punitive damages would legally be compensatory damages and therefore not taxed.

If you are in the negotiation phase of a settlement, you want the entire amount awarded to you to be treatd as compensatory damages. That way it is not taxable to you.

Answer 4

Regarding settlements received in lawsuits:

Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

From publication 17, Internal Revenue Service, page 86.

Answer 5

Any settlement amount you received from an insurance company for injury is not taxable provided you had paid for the insurance policy.

Answer 6

A disability settlement is a non taxable event so you have nothing to estimate. It is free of all Federal, State and Local taxes.