Introduction
If you settled a lawsuit, you might wonder: Will I get a 1099 for a lawsuit settlement? The answer is: sometimes yes, sometimes no. It depends on why you were paid and how the payer reports the payment. This article explains the rules in plain language. It will help you understand when a 1099 is likely, what different forms mean, and what to do if you get one.
Quick Answer - Do Lawsuit Settlement Payments Require a 1099?
Short answer: It depends on the type of payment. If the settlement is for physical injury or sickness, it’s usually not taxable and often not reported on a 1099. But payments for lost wages, emotional distress (not from physical injury), punitive damages, or interest usually are taxable and often get reported on a 1099 or other tax form.
What is a 1099 And Why It Matters For Lawsuit Settlements
A 1099 is a group of IRS forms used to report income that is not paid as wages. The most common is Form 1099-MISC. The IRS gets a copy of the 1099 you receive. That tells the IRS you were paid. If you get a 1099, the IRS expects you to report the income on your tax return. But getting a 1099 does not always mean the money is taxable. Sometimes payers send 1099s even when part of the settlement is tax-free. That is why it is important to know what the payment was for.
Why You Should Include a “No-1099” Provision in Settlement Agreements
At the recent annual conference of the Society of Settlement Planners, one of the presenters suggested adding a provision regarding Form 1099s to settlement agreements.
Defendants or their insurers will often send plaintiffs a 1099, even though the underlying claim is for personal physical injuries (and therefore should not be sent a 1099). Your client (or you) then has to contact the defendant and rely on their cooperation and goodwill to remedy this problem.
However, rather than having to rely on the cooperation of the defense, plaintiff attorneys should include a provision in the settlement agreement stating that the defendant agrees not to send a 1099 to the plaintiff.
An example of such a provision is as follows:
“All sums set forth above constitute compensatory damages paid on account of personal physical injuries or physical sickness, arising from an occurrence within the meaning of Section 104(a)(2) of the Internal Revenue Code of 1986, as amended. Therefore, neither the defendant nor any of its insurers shall send an IRS Form 1099 to the plaintiff for any amount paid under this agreement.”
If you include a “no-1099” provision and the defense sends a 1099 to your client, rather than having to rely on the cooperation of the defense to fix the problem, you can indicate that the defense acted in violation of the settlement agreement. This should make it easier to remedy an incorrectly sent 1099.
It should be noted that the above provision complies with the instructions for Form 1099-MISC, which state the following: “…[D]o not report damages (other than punitive damages) … [r]eceived on account of personal physical injuries or physical sickness.”[1] Similar language is also be found on the IRS website.[2]
When You Will Receive a 1099 for a Lawsuit Settlement
- Payments for punitive damages: These are meant to punish the defendant. Punitive damages are taxable and usually reported on Form 1099-MISC as “other income.”
- Interest that accrues before or after the settlement: Interest is taxable and often gets reported on Form 1099-INT or Form 1099-MISC.
- Emotional distress not tied to a physical injury: If emotional distress is not from a physical injury, it is usually taxable and may be reported on a 1099.
- Payments characterized as lost wages or back pay: Wages are taxable and should be reported on a W-2 if paid by an employer. If paid by someone else, the payer may issue a 1099 for other income.
- Gross proceeds paid to an attorney: If the payer issues the check to the attorney, the payer may file Form 1099-MISC, Box 10, reporting gross proceeds paid to an attorney when required by the IRS rules.
When You Will Not Receive a 1099 for a Lawsuit Settlement
- Compensatory damages for physical injury or physical sickness: These are generally not taxable and usually not reported on a 1099.
- Medical expenses arising from physical injury: Amounts that reimburse medical costs for physical injury typically are tax-free and not reported.
- Portions of a settlement the payer correctly classifies as tax-exempt: If the settlement expressly allocates amounts to non-taxable items and the payer follows that allocation, you may not get a 1099 for that portion.
Types of Lawsuit Settlements and Their 1099 Treatment
Physical injury or sickness settlements
- Tax rules: Generally tax-free when the payment compensates for physical injury or physical sickness. This includes amounts for medical bills, pain and suffering tied to the physical injury, and lost wages caused by the physical injury (special rules apply to lost wages).
- Reporting: Usually no 1099 is issued for the non-taxable part. But interest on the amount or punitive damages could be taxable and reported.
Emotional distress settlements
- Tax rules: If emotional distress is directly tied to a physical injury, it can be non-taxable. If it is not tied to physical injury, it is usually taxable.
- Reporting: Non-physical emotional distress payments may be reported on a 1099 and are taxable income.
Punitive damages
- Tax rules: Punitive damages are almost always taxable.
- Reporting: Often reported on Form 1099-MISC as other income.
Employment and wage claims
- Tax rules: Back pay and lost wages are taxable as ordinary income. They usually have payroll taxes withheld if paid by the employer. If the settlement is paid by a third party, it can still be taxable.
- Reporting: Employers should report wage-related settlements on a W-2. Third parties may issue a 1099 for non-wage payments.
Structured settlements
- Tax rules: Payments spread out over time might be tax-free when they compensate for physical injury. The tax treatment depends on the reason for damages.
- Reporting: The structure of payments can change reporting. The payer and your attorney should clarify how each payment is treated.
Attorney fees and gross proceeds to attorneys
- Tax rules: The rules about attorney fees and their tax treatment can be complex. Whether fees are deductible and how they affect your taxable income depends on the kind of claim.
- Reporting: If the payer pays the attorney directly, the payer often must file Form 1099-MISC, Box 10, to report gross proceeds paid to an attorney. The attorney then reports what they received. Sometimes both the attorney and the plaintiff receive 1099s.
What To Do If You Receive a 1099 for a Settlement
- Don’t panic. Getting a 1099 does not automatically mean you owe tax on the whole amount.
- Check the reason for the payment. Look at your settlement agreement and see how amounts were allocated. Did the agreement say the payment was for physical injury, emotional distress, punitive damages, or lost wages?
- Contact the payer. If the 1099 is wrong, ask the payer to issue a corrected form. Sometimes payers misclassify payments by mistake.
- Ask your attorney. Your lawyer can contact the payer and request a corrected 1099 or other paperwork that clarifies the allocation.
- Keep records. Save the settlement agreement, letters, and correspondence. Keep medical bills, receipts, and proof of injury. These documents will help you or your tax advisor show why the money should or should not be taxable.
- Talk to a tax professional. Tax rules about settlements can be complicated. A CPA or tax attorney can tell you how to report the amount and what deductions or credits might apply.
How Lawsuit Settlement Taxes Are Typically Calculated
- Determine what part of the settlement is taxable. First separate amounts for physical injury, medical bills, punitive damages, interest, and lost wages.
- Interest and punitive damages are added to your taxable income. They are taxed at normal income tax rates.
- Lost wages are taxed as ordinary income. Payroll taxes may also apply.
- Non-taxable portions (like many physical injury payments) are not included in your taxable income.
- Attorney fees: How attorney fees affect your taxes can be tricky. Rules changed in recent years, and deductions for many legal fees were limited. Ask your tax advisor how to treat fees in your situation.
- If you received a Form 1099 showing gross proceeds, you may need to report taxable portions on Schedule 1 (Form 1040) as “other income,” or on the correct line for wages if the payment is treated as wages.
- If you paid taxes on a 1099 that later gets corrected, you can file an amended return (Form 1040-X) to get a refund.
Frequently Asked Questions (FAQs)
Do All Settlement Checks Trigger IRS Reporting?
No. Not all settlement checks trigger a 1099. Whether a 1099 is issued depends on the type of payment and IRS reporting rules. Payments for physical injury or sickness are usually not reported because they are typically not taxable. But payments for punitive damages, interest, or lost wages often trigger reporting.
What Happens if the Name on the 1099 is Incorrect?
If the name or Social Security number is wrong, contact the payer and ask for a corrected 1099. Keep records of your request. The payer can issue a corrected form to the IRS. If the payer does not correct it, show proof of the error to your tax professional and attach an explanation when you file.
Are Out-Of-Court Settlements Reported the Same Way?
Yes. Whether a settlement is in court or outside court does not change the tax rules. What matters is the reason for the payment. Out-of-court settlements that are taxable should be reported to the IRS. The payer may issue a 1099 or other form based on what the payment was for.
Conclusion
Will I get a 1099 for a lawsuit settlement? It depends on why you were paid and how the payer reports the payment. Many physical injury settlements are tax-free and often do not result in a 1099. But interest, punitive damages, emotional distress not tied to physical injury, and lost wages are usually taxable and may be reported. Always review your settlement agreement, keep good records, and talk to your lawyer and a tax advisor if you get a 1099. If you think a 1099 is wrong, ask the payer for a correction and keep copies of your requests.
[1] https://www.irs.gov/instructions/i1099mec
[2] https://www.irs.gov/government-entities/tax-implications-of-settlements-and-judgments
