Because of my age, my employer wanted to terminate my employment. I signed a statement not to sue and received a lump-sum payment from my employer for age discrimination. Is this payment taxable?

Written by FreeAdvice Staff

The Internal Revenue Service (IRS) is very clear on the taxability of proceeds received from a lawsuit settlement. Generally, proceeds received from settlements involving damage to economic interests or property must be reported as income to the taxpayer. Receiving a lump sum payment in exchange for the promise not to sue based on age discrimination classifies as a settlement. According to the IRS, any funds received from a settlement are taxable and must be included as gross income.

Assume Mary entered into a settlement agreement and received $10,000, but she also hired a lawyer to negotiate the terms of the settlement and this lawyer charged Mary $2000. After deducting the lawyer's cost, Mary only received $8,000. However, the IRS requires Mary to include the full $10,000 in her income. However, Mary can deduct the $2000 cost of legal representation on Schedule A of her tax return as a miscellaneous itemized deduction.

There are certain types of settlements that can be excluded from gross income. If a taxpayer settles a claim involving a physical injury or sickness, the proceeds from those types of settlements are usually non-taxable. Other settlements may also be subject to regular withholding. A settlement that might be subject to withholding whether or not you continue to work for the employer might be one that is classified as "back pay."

 

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