From a legal perspective, when individuals and businesses get a lawsuit settlement, it is important to know the tax regulations. Of all the basic types of settlements, product liability settlements are likely to have special tax features. The taxes applicable on the lawsuit settlement can change the amount received considerably, therefore it’s important to understand the laws of similar cases.
For this, our blog will be analyzing of what product liability settlements involve, the implication of taxes, and how the recipient is or can be prepared for the tax bills.
What is a product liability settlement?
Product liability is the legal concept whereby a product is responsible for injury or damage to a customer. These usually consist of defective equipment, toxic drugs, or ill-conditioned vehicles. The common scenarios involve the victims suing manufacturers, distributors or retailers and this result to the claimants being awarded compensations to cater for their medical bills, wages lost and for the injury suffered.
Such settlements are normally distinguished into certain categories, including general, punitive or even interest. Every category may have a different tax treatment under the laws that regulate the taxation of lawsuit settlement
Taxable vs. Non-taxable portions of product liability settlements
Not all parts of a lawsuit settlement are taxed the same way. Here’s how the components of a product liability settlement are generally treated for tax purposes:
1. Compensatory Damages for Physical Injuries
Any compensation that is to be sought for actual physical harm or disease arising out of a defective product is generally a non-taxable compensatory damage award. This also means that if you are paid for the medical expenses that were a result of the injury inflicted on you, then you do not have to pay your State taxes for that amount.
2. Emotional Distress or Mental Anguish
If emotional distress arises out of physical injury, this portion of the award will not be taxed. However, if one is not accompanied by a physical injury, the IRS may consider it taxable.
3. Punitive Damages
Unlike compensatory damages, all punitive damages are taxable. These are received as a penalty on the manufacturer or the responsible party and are likely to be received as operating income.
4. Lost Wages
Any part of the settlement which relates to pay for lost earnings because the person cannot work then this is taxable as it is a substitution for earnings.
5. Interest on settlement accounts
Any interest earned on the settlement amount is taxable as well.
Taxes on Lawsuit Settlement: Product Liability-Specific Concerns
In product liability cases, settlements often include a combination of the above categories. Recipients should be aware of how their settlement is structured to understand their tax obligations fully. Below are key considerations specific to product liability:
1. Medical Expense Deductions
The settlement amount for any medical costs associated with the injury that you previously deducted will be taxed.
2. Allocation of settlement amounts
Settlements often do not specify how much is awarded for each type of damage. In such cases, the IRS may allocate amounts based on the case’s details, potentially increasing the taxable portion.
3. Legal Fees
Although legal fees are capable of adding up to a big amount in product liability suits, most of the time they are not tax deductible. This means you might have to part with all the money received; the balance received together with the amount paid to your attorney.
Preparing for Taxes on Product Liability Settlements
To effectively manage the taxes on lawsuit settlement, especially in product liability cases, consider these steps:
1. Seek Professional Advice
Consult a tax professional or attorney experienced in lawsuit settlements. They can assist you in comprehending the particular tax ramifications of your settlement.
2. Review the Settlement Agreement
Ensure the settlement agreement specifies the allocation of amounts for different types of damages. This can help minimize taxable income.
3. Set Aside Funds for Taxes
Since some portions of the settlement are taxable, set aside a portion of the funds to cover tax obligations. This avoids surprises during tax season.
4. File Necessary Forms
Ensure all relevant forms, such as Form 1099-MISC, are correctly filed with your tax return.
This content is meant for information only and should not be considered as an advice or legal opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.