Tax Consequences for Litigation Recoveries

Many of my clients are aware of the fact that personal injury recoveries, whether by settlement or verdict, are not taxable as income. Invariably, even if they were not aware of this, a friend or loved one will so inform them. When I first began to work for a law firm in the late 1980’s, many non-personal injury recoveries were also treated as non-taxable, and incorrectly so. In the 1990’s, taxing authorities began to crack down on this practice. Now, the regulations and legal decisions make it clear that virtually any recovery in my business an employment litigation practices will have a tax consequence of some sort. That said, the parties may have some flexibility in terms of how a recovery will be taxed. The actual claims asserted in the litigation drive this process. For instance, lost wages claims will likely have to be treated as wages when recovered, and thus subject to payroll taxes and withholding. On the other hand, non-employee compensation claims will not be subject to payroll taxes and withholdings, although they will still be considered income and reported to the IRS on Form 1099 as such. Although it is crystal clear that a litigant cannot avoid taxes on business litigation recoveries, there are still perfectly lawful approaches that can be utilized to minimize the taxes due. Litigants are advised to consult with their counsel and tax professionals to explore these avenues before entering into settlement agreements.