Your car got rear-ended while stopped at a red light. Your contractor did shoddy work on your condo. You were unfairly fired. Someone did you wrong and now youre collecting a settlement payment or judgment. Is it taxable income? Usually yes, but the tax treatment can vary enormously, depending on how you were damaged, how the case was resolved, how the checks and IRS Forms 1099 were issued and other variables.  Here are 10 things you should know about the taxation of settlements.  1. Settlements and judgments are taxed the same.  The same tax rules apply whether you are paid to settle a case or win a lawsuit judgment, or even if your dispute only reached the letter-writing phase. Despite the similarities, though, you'll almost always have more flexibility to reduce taxes if a case settles rather than goes to judgment.  If you are audited, you'll need to show what the case was about and what you were seeking in your claims. Consider the settlement agreement, the complaint, the checks issued to resolve the case, IRS Forms 1099 (or W-2), etc. You can influence how your recovery is taxed by how you deal with these issues.  2. Taxes depend on the "origin of the claim."  Settlements and judgments are taxed according to the item for which the plaintiff was seeking recovery (the "origin of the claim"). If you're suing a competing business for lost profits, a settlement will be lost profits, taxed as ordinary income. If you get laid off at work and sue for discrimination seeking wages and severance, you'll be taxed as receiving wages. In fact, your former employer will probably withhold income and employment taxes on all (or part of) your settlement even if you no longer work there.  But if you sue for damage to your condo by a negligent building contractor, your damages usually won't be income. Instead, the recovery will be treated as a reduction in your purchase price of the condo. These rules are full of exceptions and nuances, so be careful. Perhaps the biggest exception of all applies to recoveries for personal physical injuries (see point 3).  3. Recoveries for personal physical injuries and physical sickness are tax-free.
You've been done wrong. You win a settlement. Now the IRS might want a cut of your damages.