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Are Class Action Settlement Payments Taxable?

Class action lawsuits normally involve a large number of people. A relatively small group of named plaintiffs represent thousands or even millions of other people, class members, who suffer losses due to the action(s) of the defendant, normally a large business. When they reach a class action settlement, individual payments are made to the class members.

The big question is “do I have to pay taxes on the money received from a class action lawsuit?“ If you are waiting for a definite “no”, we have to disappoint you. There is no definite “yes” or “no” answer to this question. It depends on the nature of the claims involved. Some settlements may be treated as taxable income while others don’t. In case the payment is not taxable, the parties may arrive at a lower class action settlement payment. However, in most cases, this is an acceptable solution for the plaintiffs because the class members will not have to report the payments as income. If that is not the case, you must remember to report the earnings to the IRS.

Taxable Settlements

Now let’s see which settlements are taxable. Normally when the action is instituted by a small business, it is economic in nature and most probably is taxable. For example, lost profits are treated as taxable income. They would be taxed anyway even if there was no lawsuit. However, if the damage payments replace a payment that would not have been taxable, most probably such income needs not to be reported.

Here are some examples of taxable settlements:

  • The recovery of costs for deductions, such as a medical expense or attorney fee deduction, constitute taxable damage.
  • Damage award payment to reimburse for medical expenses when it comes to emotional distress if the expense was deducted for tax purposes.
  • Payments for damage to reputation, defamation of character or libel.
  • Accrued interest paid on damages.

Non-Taxable Settlements

Luckily, not all settlements are taxable. Examples include settlements for physical injury or sickness unless the claimant received a tax benefit by deducting medical expenses. Not all damages are considered “physical injury.” For example, insomnia or stomachaches may not qualify as “physical injury”. But if faulty washing machine caused you physical harm, the earning might not be taxable. Similarly, emotional distress settlements are non-taxable but if the distress is not caused by a physical injury, then most likely you will be taxed.

Other examples of non-taxable settlements include:

  • Lost wages, medical expenses (if not previously deducted), pain and suffering.
  • Medical expenses as well as legal fees as long as they were not previously deducted for tax purposes.
  • The value of injunctive relief.

You need to consult an attorney for each individual case. The general rule is that the persons or businesses engaged in a trade or business are responsible for filing Form 1099-MISC to report payment of over $600. This includes class action settlements payment and damage awards. Typically, IRS considers the reception of anything of value as taxable income.

Luckily you are on our page! You can contact The Margarian Law Firm for a free consultation. Our attorneys have a proven record dealing with class action lawsuits. Please call us today at (818) 553 -1000 for a fast and FREE consultation with one of our experienced class action lawsuit attorneys.

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