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Settlements and Taxes

The recent $2.5 Billion Black Farmers Settlement has awarded each of its 17,000 plaintiffs $50,000 and an additional $12,500 toward taxes. The lawsuit was in part to seek financial retribution for some of those African American farmers who struggled financially due to discrimination. Clearly, $50,000 hardly covers a lifetime of denied loans and declined supply contracts that these farmers still face. It may seem unfair that these farmers have to give up that additional $12,500 to taxes. It is especially irksome when one considers the lawsuit was against the USDA, a tax-funded government administration.

taxes on settlementsHowever, the rules are the rules when it comes to taxes, and the IRS has very specific rules about taxing on settlements. The IRS lists certain scenarios when a settlement should or should not to be included as income on a tax return. However, they often are not as cut and dry as they seem. Below are a couple examples that seem clear, but may not be:

  1. 1.  Settlements based on personal physical injuries or physical sickness should not be included as income on your tax return, except for any portion of that settlement meant to pay for past medical expenses that you documented on your income taxes to receive a benefit.
  1. 2.  Settlements based on emotional distress or mental anguish should not be included as income on your tax return, except for any income that did not originate from a personal physical injury or physical sickness.

Those benefitting from the Black Farmers Settlement are receiving money based on lost wages or lost profits. In this scenario, the $62,500 allotted to each plaintiff is viewed as wages they would have made if not for the discrimination they experienced. Wages are income and they are taxable. $12,500 is what would be taxed without any kind of exemptions, dependents, etc in mind. Truthfully, that is a 20% tax that most of those 17,000 farmers would not pay on one of their normal tax returns for wages. Some this settlement’s plaintiffs may find that they can receive some of the money sent directly to the IRS as a tax back as a refund. This even includes the beneficiaries of one farmer’s estate, which would not example of taxing a settlement as wages but rather would be estate taxes.

Regardless of the type of scenario or taxes being filed for the beneficiary of a settlement, it is best that he or she works with a reputable tax professional. Obviously, it is in a person’s best interest to retain as much of a settlement as possible. However, not paying the IRS its due usually leads to losing much more money than just paying the highest tax due to begin with. A tax professional helps to navigate that fine line so that you wind up in the best situation financially.