Tax Consequences of Settlement and Litigation Award Payments: Determining the Correct Treatment

By Eric Smith
The CPA Journal
November 2018 Edition

When an individual receives a settlement or litigation award payment, the likely first question is whether the payment is taxable. While CPAs may know that the answer will depend upon the claim underlying the lawsuit, several other questions can arise that will likewise depend on the facts and circumstances. These questions include: What about the treatment of attorney fees that will be paid out of the settlement or award payment? What if the individual’s attorney represents multiple parties to the lawsuit? Will the settlement or award payment be subject to withholding for income and employment taxes if paid by the individual’s employer?

Determining the correct treatment of settlement and litigation award payments is a multistep process requiring the determination
of the character of the payment and the nature of the claim that gave rise to it; whether the payment constitutes an item of gross income; if the payment relates to an employment claim, whether the payment is wages for employment tax purposes; and the appropriate reporting for the payment of any attorney’s fees.

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