Are wrongful termination settlements taxable?

As you navigate the complexities of losing a job due to wrongful termination, one burning question may arise: Are wrongful termination settlements taxable?

Besides being emotionally challenging, losing a job due to wrongful termination can also lead to a long legal battle.

The result of such legal battles is usually a settlement.

Let’s explore this aspect to shed light on what you might expect from a tax perspective.

An image illustrating Are wrongful termination settlements taxable?
Are wrongful termination settlements taxable?
Source: The US Sun

What are wrongful termination settlements?

Wrongful termination settlements typically arise when an employee and an employer reach an agreement to resolve a legal dispute related to the employee’s dismissal.

The settlement amount is often negotiated to compensate the employee for damages, lost wages, emotional distress and any other relevant factors.

Are wrongful termination settlements Taxable or Non-Taxable?

The taxability of wrongful termination settlements depends on the nature of the compensation.

Generally, the IRS views settlements replacing lost wages or back pay as ‘income or a benefit from employment’. Under the Income Tax Act, this kind of settlement is taxable.

This means you will likely need to report these amounts as wages or income on your income tax return.

Some parts of a settlement, however, may not be taxed.

For instance, compensation for emotional distress, especially if it comes from physical injury or illness, is often tax-free.

It’s therefore important to distinguish between different parts of the settlement to understand the tax impact correctly.

Initially, when filing a wrongful termination claim, you canĀ  involve a skilled attorney to help list all the various damages.

Listing all the damages being sought ensures we can consider including specific non-taxable categories in a settlement

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IRS guidelines for the taxability of wrongful termination settlements

According to IRS, you can exclude from your total income, any amount of money you get as damages due to personal injuries or physical sickness.

This applies whether you get the money through an agreement, a lawsuit or lump sum or installments.

Moreover, you may consider consulting a tax expert or a wrongful termination attorney for additional insights on how settlements are treated for tax purposes.

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