By using this site, you agree to our Privacy Policy and our Terms of Use.

Understanding Tax Implications on Different Types of Lawsuit Settlements

A pair of business men across a table shaking hands

When you secure a financial settlement from a lawsuit, it's crucial to understand the associated tax implications. There are two primary types of damages you could receive from a lawsuit: compensatory and punitive. Each of these damages has different tax implications, which we will explore in this article.

Overview of Lawsuit Settlements

Lawsuit settlements are financial awards granted to plaintiffs to compensate for their losses and/or to punish the defendant for their actions.

Types of Lawsuit Damages

Compensatory Damages

Compensatory damages compensate the plaintiff for the actual losses sustained due to the defendant's actions. These damages aim to restore the plaintiff's financial status as if the incident leading to the lawsuit had not occurred.

Economic Damages

Economic damages are quantifiable monetary costs incurred by the plaintiff. These include medical expenses, property damage, and lost wages due to missed work.

Non-Economic Damages

Non-economic damages cater to intangible losses such as pain and suffering, mental anguish, and decreased quality of life. Assigning a monetary value to these damages can be challenging as they are subjective and vary from case to case.

Punitive Damages

Punitive damages punish the defendant for reckless behavior and deter others from committing similar acts. They are usually awarded in cases where the defendant's conduct was particularly egregious.

Tax Implications of Lawsuit Settlements

Taxability of Compensatory Damages

The reason for the award determines the taxability of compensatory damages. Generally, compensatory damages for physical injuries are not taxable income, implying that you do not need to report it as taxable income if your lawsuit settlement includes compensatory damages for bodily injuries.

However, non-physical injuries such as emotional distress, defamation, and humiliation are typically taxable income. See Plaintiff Recovery Trust for solutions to reduce taxation on settlements and Understanding Intricacies of Plaintiff Taxation.

Taxability of Punitive Damages

Unlike compensatory damages, punitive damages are always taxable, regardless of the reason for the award. They must be reported as "Other Income" when filing taxes. See Plaintiff Recovery Trust for solutions to reduce taxation on settlements and Understanding Intricacies of Plaintiff Taxation.

Tax Planning for Lawsuit Settlements

Tax planning is crucial before settling a lawsuit to avoid surprise tax bills. It's essential to know the breakdown of your settlement, and understand which portions of the damages are compensatory and which are punitive, for tax purposes.

Allocation of Damages

It's possible to allocate damages into compensatory and punitive categories to optimize tax treatment. While this allocation does not bind the IRS, the IRS usually does not ignore these agreements.

Attorney Fees and Taxes

If you hire a contingency fee lawyer, 100% of the money recovered is considered received by you for tax purposes, even if your lawyer takes a percentage off the top. Thus, you will be liable to pay taxes on the entire settlement amount, not just your share after attorney fees.


Understanding the tax implications of your lawsuit settlement can help you plan your finances better and avoid potential tax liabilities. It's always a good idea to consult with a tax professional or attorney to understand the tax implications of any damages you may receive.

And remember, the tax treatment of damages can be complex. So, having a knowledgeable industry leader to guide you through these complex financial matters is invaluable.

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.
Article Archive

Get More Information

Your submission has been received.
A member of our team will be in touch with you soon.
Something went wrong while submitting the form.
Please see our Contact Us page for more options to connect with us.