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Maximizing A Court Award - Strategic Tax Planning for Post-Judgment Interest

Maximizing A Court Award - scales and money

Introduction

You prevailed and won the case, and the award includes post-judgment interest – now, taxes are due on the interest.

Unfortunately, many people are taken aback when they find out that post-judgment interest is always taxable in cases involving injuries.

Knowing how this interest is taxed and being ready for it is often overlooked when planning for matters. This discussion focuses on the tax implications of post-judgment interest in physical injury cases and ways to reduce its tax burden.

Tax forms and money

Is Post-judgment Interest Material?

The notion that post-judgment interest is not material can be fatally flawed. As the appeals process can drag on for years, it is not at all unusual for post-judgment interest to be significant. In today’s courts, cases with millions of dollars in post-judgment interest are not rare.


Pro-Tip: As time passes, tax planning options diminish. Therefore, the time to start planning to mitigate post-judgment interest taxation is before the case is final – the earlier, the better.


Understanding the Taxation of Awards

  • Generally, compensation for physical injuries or sickness is non-taxable, including the associated medical bills and lost wages.
  • On the other hand, damages for non-physical injuries (such as emotional distress), defamation, and humiliation are ordinarily taxable.

Pro Tip: Taxation of Post Judgement Interest Still Applies Under IRC Section 104. Damages received for injuries or sickness are not taxable gross income under §104(a)(2). However, it’s important to note that this tax exemption does not extend to damages or post-judgment interest. As a result, punitive damages and post-judgment interest are always subject to taxation, irrespective of the type of injury.


Pro Tip: Legal Fees and Deductions.

The 2017 tax law eliminated the deduction for attorney fees linked to awards or settlements. As a result, individuals filing lawsuits now need to include the entire amount of their taxable recoveries as taxable gross income without being able to deduct any legal fees. For more details, click Double Tax.


Tax Planning Strategies for Recipients of Post-Judgment Interest

Utilizing Plaintiff Recovery Trusts

The Plaintiff Recovery Trust (PRT) allows plaintiffs to reduce the tax implications of taxable awards (including post-judgment interest). This specialized trust enables plaintiffs to skip paying taxes on the attorney fee portion of the judgment or settlement, including those linked to judgment interest. As a result, the PRT offers the advantage of helping plaintiffs retain a greater after-tax percentage of the award.

Case Study - Client Results using the PRT only Diagram

Structured Settlement Annuities and Tax Benefits

Structured settlement annuities, while beneficial, offer less effective strategic tools for plaintiffs to reduce the taxation on post-judgment interest. By spreading payments over many years, plaintiffs can spread the realization of the taxable income, which may result in minor tax benefits by lowering the applicable tax rate. However, these tax savings can be illusory, as future federal or state tax rate increases could result in even greater taxation.

Conclusion

Navigating the complexities of post-judgment interest and its tax implications is often an overlooked planning element. The Plaintiff Recovery Trust typically will offer the best taxation outcomes on post-judgment interest awards, and by preplanning to utilize the PRT, recipients can significantly enhance their economic results.

As such, when the possibility exists of court awards with post-judgment interest, one should proactively engage in tax planning strategies EARLY – waiting until after the final award or the appeal is often too late.

Disclosure: This content is an overview. It is not a detailed analysis and offers no legal or tax opinion on which you should solely rely. Always seek the advice of competent legal and tax advisors to review your specific facts and circumstances before making any decisions or relying on the content herein.
Any opinions, views, findings, conclusions, or recommendations expressed in the content contained herein are those of the author(s) and do not necessarily reflect the view of the Eastern Point Trust Company, its Affiliates, or their clients. The mere appearance of content does not constitute an endorsement by Eastern Point Trust Company (“EPTC”) or its Affiliates. The author’s opinions are based upon information they consider reliable, but neither EPTC nor its Affiliates, nor the company with which such author(s) are affiliated, warrant completeness, accuracy or disclosure of opposing interpretations.

EPTC and its Affiliates disclaim all liability to any party for any direct, indirect, implied, special, incidental, or other consequential damages arising directly or indirectly from any use of the content herein, which is expressly provided as is, without warranties.
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