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5 Causes Of Unexpected Federal Tax Debt

5 Causes Of Unexpected Federal Tax Debt

Most people do not realize that when you are awarded a financial amount as part of a case settlement or judgment, you are responsible for paying taxes on that amount. If you do not properly report this as income on your tax documents you may be subject to serious penalties from the IRS.

Watch out for these 5 top causes that could leave you with serious federal tax debt.

  1. Damages awarded for personal injury

In a legal sense, any financial award for injury or physical sickness is tax-free, but the IRS bases this on a fairly unclear definition of injury. Typically, to be defined under this guideline, there must be physical damage that is observable, as in the case of broken bones.

  1. Damages for emotional distress

These amounts are subject to tax, although if emotional distress is related to an injury the amount may not have to be taxed. Again, this requires meeting a higher standard than most emotional distress cases.

  1. Damages for property

When an amount is awarded for property damage, it will only be taxable if the financial award is more than the cost of the damage or property.

  1. Lost profits rewards

There are certain legal situations in which lost profits or income are awarded in judgments. For business-to-business lawsuits, the financial amount may be tied to the profits lost because of a competitor’s actions. For employment suits, an employee may receive severance payment or financial reward for unjust dismissal or discrimination. Both of these cases require paying taxes on these amounts as though they were regular income. However, if a settlement is tied to injury or harm obtained at a workplace or because of an employer, the damages awarded may not be subject to tax.

  1. Other types of damages

Most other types of judgment rewards will also be subject to tax under IRS guidelines. Breach of contract settlements are common, as are punitive damages; both ultimately must be reported and taxed.

After a challenging legal case you don’t want to find yourself with a heap of penalties from the IRS, so whenever you receive a financial settlement or judgment it is up to you to verify whether the income needs to be reported, and how to do so. Most types of settlements are taxed, so make sure you speak with legal and accounting professionals to prepare accordingly.

Finding the right lawyer is the best way to make sure you are receiving accurate information. A tax lawyer like Attorneys Tax Relief LLCcan make sure that you are following all the right steps at the time of your judgment, so you don’t have any problems at tax time or in the future.