According to the district court, the IRS cannot be sued for emotional distress due to sovereign immunity. Are settlements for pain and suffering taxable? The answer depends on the nature of your pain and suffering. Physical pain and suffering aren't taxable, but the IRS bundles them together with medical expenses. Emotional pain and suffering, on the other hand, are taxable only if they are separate from physical injury or illness.
Depending on the type of pain and suffering, you may be able to get a deduction for some of your expenses. However, the IRS does not comply with the terms of settlement agreements. Their opinion may differ from yours. That's why it's essential to consult a tax professional or lawyer before reaching an agreement.
In addition, it is crucial to consider how to distribute damages to minimize taxes. Some agreements may only be taxable in certain states, so check with your lawyer to determine the best course of action. As a general rule, profits received from most personal injury claims are not taxable under federal or state law. It doesn't matter if you settled the case before or after you filed a personal injury lawsuit in court.
It doesn't matter if you went to trial and won a verdict. Neither the federal government (the IRS) nor your state can tax you on the proceeds of the settlement or verdict in most personal injury claims. Federal tax law, for example, excludes damages received as a result of personal physical injury or physical illness from the taxpayer's gross income. The Tax Court said that the IRS was wrong to argue that you can never suffer physical injury or physical illness in a lawsuit for emotional distress.
If the settlement agreement says nothing about whether the damages are taxable, the IRS will analyze the payer's intention to describe the payments and determine the reporting requirements for Form 1099. The first group includes claims related to physical injuries and the second group is claims related to non-physical injuries. While the IRS can always challenge the non-taxation of a settlement, specifically assigning your agreement this way gives you the best chance of having most of the agreement excluded from taxes. You don't want to be surprised that IRS forms W-2 and 1099 arrive unexpectedly in January of the year following the agreement. Therefore, forms 1099-MISC and forms W-2, as appropriate, must be filed and delivered with the plaintiff and attorney as beneficiaries when the attorney's fees are paid in accordance with a settlement agreement that provides for payments included in the claimant's income, even if only a check can be issued for the attorney's fees.
These agreements are not binding on the IRS or on the courts in subsequent tax disputes, but they are generally not ignored by the IRS. Accordingly, defendants issuing a settlement payment or insurance companies issuing a settlement payment must issue a 1099 form, unless the agreement qualifies for one of the tax exceptions. If you are fired at work and file a lawsuit for a salary, you will be taxed as a salary and some will probably pay on Form 1099 for emotional distress. This ensures that you can prove to the IRS that part of the verdict was for compensatory damages, which are not taxable.
