Settlement Agreement Payment: Is it Taxable?
When a settlement agreement is reached between two parties, one of the most common questions asked is whether the payment is taxable or not. In most cases, a settlement payment is taxable, but there are certain exceptions.
To begin with, it`s important to understand what a settlement agreement is. A settlement agreement is a legally binding agreement between two parties where one party agrees to pay the other a sum of money in exchange for the other party dropping any legal action against them. Settlement agreements can involve a wide range of issues, including employment disputes, personal injury claims, and intellectual property disputes.
When it comes to the taxation of settlement payments, the Internal Revenue Service (IRS) has a few basic rules. Most settlement payments are considered taxable income unless the payment falls under one of the following exceptions:
1. Physical Injury or Sickness: If the settlement payment is related to a physical injury or sickness, then the payment is generally not taxable. This includes compensation for medical expenses, lost wages, and pain and suffering.
2. Emotional Distress: If the settlement payment is related to emotional distress, then the payment may or may not be taxable. Generally, if the emotional distress is related to a physical injury or sickness, then the payment is not taxable. However, if the emotional distress is not related to a physical injury or sickness, then the payment is taxable.
3. Punitive Damages: If the settlement payment includes punitive damages, then the payment is generally taxable. Punitive damages are meant to punish the defendant for their actions, not compensate the plaintiff.
It`s important to note that even if a settlement payment is not taxable, the plaintiff may still be required to report the payment on their tax return. The plaintiff should consult with a tax professional to determine how to properly report the settlement payment.
In conclusion, settlement payments are generally taxable unless they fall under one of the exceptions mentioned above. If you are involved in a settlement agreement, it`s important to consult with a tax professional to determine the tax implications of the payment.