Maximizing A Court Award - Strategic Tax Planning for Post-Judgment Interest
Introduction
You prevailed and won the case, and the award includes post-judgment interest – now, taxes are due on the interest.
Unfortunately, many people are taken aback when they find out that post-judgment interest is always taxable in cases involving injuries.
Knowing how this interest is taxed and being ready for it is often overlooked when planning for matters. This discussion focuses on the tax implications of post-judgment interest in physical injury cases and ways to reduce its tax burden.
Is Post-judgment Interest Material?
The notion that post-judgment interest is not material can be fatally flawed. As the appeals process can drag on for years, it is not at all unusual for post-judgment interest to be significant. In today’s courts, cases with millions of dollars in post-judgment interest are not rare.
Pro-Tip: As time passes, tax planning options diminish. Therefore, the time to start planning to mitigate post-judgment interest taxation is before the case is final – the earlier, the better.
Understanding the Taxation of Awards
- Generally, compensation for physical injuries or sickness is non-taxable, including the associated medical bills and lost wages.
- On the other hand, damages for non-physical injuries (such as emotional distress), defamation, and humiliation are ordinarily taxable.
Pro Tip: Taxation of Post Judgement Interest Still Applies Under IRC Section 104. Damages received for injuries or sickness are not taxable gross income under §104(a)(2). However, it’s important to note that this tax exemption does not extend to damages or post-judgment interest. As a result, punitive damages and post-judgment interest are always subject to taxation, irrespective of the type of injury.
Pro Tip: Legal Fees and Deductions.
The 2017 tax law eliminated the deduction for attorney fees linked to awards or settlements. As a result, individuals filing lawsuits now need to include the entire amount of their taxable recoveries as taxable gross income without being able to deduct any legal fees. For more details, click Double Tax.
Tax Planning Strategies for Recipients of Post-Judgment Interest
Utilizing Plaintiff Recovery Trusts
The Plaintiff Recovery Trust (PRT) allows plaintiffs to reduce the tax implications of taxable awards (including post-judgment interest). This specialized trust enables plaintiffs to skip paying taxes on the attorney fee portion of the judgment or settlement, including those linked to judgment interest. As a result, the PRT offers the advantage of helping plaintiffs retain a greater after-tax percentage of the award.
Structured Settlement Annuities and Tax Benefits
Structured settlement annuities, while beneficial, offer less effective strategic tools for plaintiffs to reduce the taxation on post-judgment interest. By spreading payments over many years, plaintiffs can spread the realization of the taxable income, which may result in minor tax benefits by lowering the applicable tax rate. However, these tax savings can be illusory, as future federal or state tax rate increases could result in even greater taxation.
Conclusion
Navigating the complexities of post-judgment interest and its tax implications is often an overlooked planning element. The Plaintiff Recovery Trust typically will offer the best taxation outcomes on post-judgment interest awards, and by preplanning to utilize the PRT, recipients can significantly enhance their economic results.
As such, when the possibility exists of court awards with post-judgment interest, one should proactively engage in tax planning strategies EARLY – waiting until after the final award or the appeal is often too late.
