In the settlement document, they award to the prevailing party should not be described as a single lump sum. Taking the award as an all-inclusive amount will kill your opportunity to avoid taxes on significant portions of it.
DESCRIBE SETTLEMENTS IN FAVORABLE TAX TERMS – Court-awarded reimbursements for medical expenses and personal injuries aren’t taxable.
Punitive damages are taxable as ordinary income. Damage awards for nonphysical injuries, such as age discrimination or injury to your reputation, are also generally taxable.
If possible, draft the settlements to describe part of a monetary award as compensation for medical expenses or personal injury, so that portion can escape taxation. If the settlement is described as a lump sum, including punitive damages and interest, the entire award is likely to be taxed. The difference in taxes could be huge.
SPLIT OFF PAYMENTS TO YOUR ATTORNEY – Tax law says you can deduct attorney’s fees that are included in a court settlement as miscellaneous itemized deductions on Schedule A.
However, these miscellaneous deductions are limited to the amount at exceeds 2% of your adjusted gross income. Plus, miscellaneous deductions are phased out for high-income taxpayers, and deductions for attorney’s fees aren’t allowed when calculating the alternative minimum tax.
It’s customary for a settlement to be reported to the recipient with a 1099-MISC form sent for the entire amount.
Request that the award be split, with one payment going to you and a separate payment going to the attorney. Make sure your contingent fee contract with your attorney reads the same way.
That way, you create a legal right on the part of your lawyer to receive part of the award instead of getting paid to you.