Now that the April tax deadline has passed, you might be wondering, “Where’s my tax refund?” Optima CEO David King and Lead Tax Attorney Philip Hwang explain how you can track your refund, how long you have to collect your refund and how to stay compliant with the IRS.
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When individuals or businesses are involved in legal disputes that result in settlements or judgments in their favor, one common question arises. Do you pay taxes on lawsuit settlements? The answer to this question can vary depending on the nature of the lawsuit, the type of damages awarded, and specific circumstances surrounding the case. Let’s look into the tax implications associated with lawsuit settlements.
Internal Revenue Code (IRC) Section 61 broadly defines gross income as all income from whatever source, unless specifically excluded by another provision of the tax code. In addition, IRC Section 104 provides an exclusion from gross income for certain types of compensation received in legal settlements or judgments. In other words, you don’t have to count certain types of money you receive from legal settlements or insurance if they’re related to personal physical injuries or sickness. However, the exact circumstances surrounding the case will help determine the taxability of settlements and judgements. Let’s look at different types of lawsuit settlements.
Compensatory damages are intended to compensate the plaintiff for losses suffered. This typically includes damages for physical injuries, emotional distress, lost wages, medical expenses, and property damage. Compensatory damages are usually not taxable. They are meant to restore the individual to the position they were in before the injury or loss occurred. Punitive damages, on the other hand, are awarded to punish the defendant for particularly egregious behavior and to deter others from engaging in similar conduct. In many cases, punitive damages are taxable as ordinary income.
If a lawsuit settlement is related to physical injury or sickness, the compensatory damages received are generally not taxable. This includes damages for medical expenses, pain and suffering, and loss of consortium. Again, if a portion of the settlement is allocated to punitive damages or other non-compensatory damages, that portion may be taxable.
Emotional distress damages are a bit trickier when it comes to taxation. Typically, damages awarded for emotional distress are taxable, even if there were physical symptoms as well. Section 104 does not consider headaches, insomnia, or stomach conditions as qualified physical symptoms. However, if you experienced a physical injury or sickness, damages might be tax-free.
Compensation for lost wages and lost profits is typically taxable as ordinary income. This includes settlements related to employment discrimination, wrongful termination, retaliation, or lost business income. This is because you are typically not suing because of physical injury. Keep in mind that not only will income taxes be due in this type of settlement, but also other wage-related taxes as well, including FICA taxes.
Attorney’s fees paid from a settlement may or may not be deductible, depending on the specifics of the case and applicable tax laws. In general, cases dealing with employment discrimination, retaliation, or whistleblower claims can deduct legal fees “above the line.” An “above-the-line” deduction is one you can claim on your tax return before calculating your adjusted gross income (AGI). As of the passing of the 2017 Tax Cuts and Jobs Act, you cannot deduct legal fees for most other cases. In addition, the Act also requires individuals to pay tax on the total gross settlement. This includes money paid to your attorney. For example, if your settlement was $20,000 and the attorney’s received $5,000, you’d pay tax on the entire $20,000 settlement and not just on your $15,000 cut. The attorney also pays their own share of tax on their cut.
When it comes to reporting lawsuit settlements on tax returns, it’s essential to accurately categorize the income and follow the IRS guidelines. If you receive settlement income, you’ll typically receive IRS Form 1099-MISC. This form is used to report miscellaneous income, including settlements. Keep in mind, however, that you won’t receive this form if your settlement income is not taxable. There may be a few exceptions to which form you’ll receive. For example, if you receive back pay from your employer, these proceeds would be reported on your W-2 Form. In addition, if you received settlement interest, you should receive IRS Form 1099-INT.
Remember, even if you don’t receive a Form 1099, you are still responsible for reporting taxable income from lawsuit settlements on your tax return. Keep detailed records of the settlement, including any documentation related to the lawsuit, legal fees, and the allocation of damages.
Navigating the tax implications of lawsuit settlements can be complex. You should consult with a tax professional or attorney for guidance tailored to your specific situation. Understanding the distinction between compensatory and punitive damages, and the tax treatment of different types of settlements, is crucial for accurately reporting income and avoiding potential tax issues in the future. By staying informed and seeking expert advice when needed, individuals and businesses can effectively manage the tax consequences of legal settlements. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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Today, Optima Tax Relief Lead Tax Attorney, Phil, talks about his three takeaways from the current tax landscape.
For much of the pandemic, we saw IRS interest rates hold steady. For example, the interest rate accumulating on unpaid taxes was 3% for half of 2020 and all of 2021. In April 2022, we saw it increase by 1% each quarter until it hit 6%. Now, the second quarter of 2024 will mark the third consecutive quarter with a rate of 8% for interest. The question remains: Will the rate continue to increase? Phil thinks so. It’s been said numerous times that now is a terrible time to owe the IRS. Spiking interest rates mean more expensive penalties and interest. Taxpayers should act immediately to get their tax issues resolved.
If you owe a significant amount of back taxes and the IRS has issued a certification to the U.S. State Department, they can deny your passport application or revoke your current passport. But don’t worry. Before the IRS certifies your tax debt to the State Department, they will notify you in writing about the impending certification. You have the opportunity to resolve your tax debt, enter into a payment plan, or request other relief options before the certification occurs.
The reporting thresholds for Form 1099-K have changed quite a bit in the past few years. Remember, Form 1099-K is an informational tax form used to report certain types of payment card and third-party network transactions to the IRS. If you collect payments for your business through PayPal, Venmo, or others, you probably know about Form 1099-K. As of now, you would receive a 1099-K in 2025 if you had transactions of $5,000 or more in 2024. However, a much smaller $600 threshold will go into effect for tax year 2025. Remember, you should report this taxable income even if you do not receive IRS Form 1099-K.
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Disposable income serves as a key economic indicator. It reflects the financial health and spending power of individuals and households. It represents the money available after taxes, providing a glimpse into how much individuals can spend, save, or invest. However, taxes play a significant role in shaping disposable income, influencing spending patterns and economic behaviors. In this article, we break down the concept of disposable income, explore its significance, and examine how taxes impact its utilization.
Disposable income (DI) refers to the amount of money individuals or households have available for spending and saving after paying taxes to the government. It is the income remaining once taxes, including income tax, payroll tax, and any other deductions, have been subtracted from gross income. Essentially, it is the money that individuals can freely allocate to consumption, savings, investments, or debt repayment.
Understanding disposable income is crucial for assessing an individual’s or household’s financial well-being. It serves as a barometer for consumer spending, which is a significant driver of economic growth. Higher DI generally correlates with increased consumer spending. This in turn stimulates demand for goods and services, leading to economic expansion.
Moreover, it influences saving and investment behaviors. Individuals with higher disposable income can save more for emergencies, retirement, or large purchases. Additionally, it enables individuals to invest in assets such as stocks, bonds, real estate, or retirement accounts, fostering wealth accumulation and financial security over the long term.
Taxes have a direct impact on disposable income, as they reduce the amount of money available for consumption and saving. In addition to federal income taxes, there is also state income tax, which varies across the country with different rates, deductions, and exemptions affecting DI differently.
Income tax is a significant contributor to reducing DI. It is imposed on earned income, including wages, salaries, bonuses, and investment income such as interest and dividends. Progressive income tax systems levy higher tax rates on higher income levels, leading to a greater reduction in disposable income for high earners.
Payroll taxes, which fund social insurance programs such as Social Security and Medicare, also diminish disposable income. These taxes are typically withheld from employees’ paychecks by employers. Payroll taxes are comprised of a fixed percentage of wages up to a certain limit. While payroll taxes are regressive, meaning they impose a higher burden on low-income earners, they still impact DI for all workers.
Consumption taxes, such as sales tax or value-added tax (VAT), are levied on goods and services at the point of purchase. Unlike income taxes, which are based on earnings, consumption taxes affect spending directly, reducing disposable income with each transaction. The regressive nature of consumption taxes means that they can disproportionately impact low-income individuals, who may spend a higher proportion of their income on taxable goods and services.
While taxes reduce DI, how individuals allocate their remaining funds can have tax implications as well. Several strategies can help minimize tax liabilities.
Contributing to retirement accounts such as 401(k) plans or individual retirement accounts (IRAs) can reduce taxable income while simultaneously saving for the future. Contributions to these accounts are often tax-deductible, lowering current tax obligations and potentially increasing disposable income.
Investing in assets with favorable tax treatment, such as municipal bonds or certain retirement accounts, can shield investment income from taxes or defer tax liabilities. This helps preserve more DI for the present.
Taking advantage of available tax credits and deductions can reduce overall tax liabilities, effectively increasing disposable income. Common tax credits include the Earned Income Tax Credit (EITC) and the Child Tax Credit, while deductions such as mortgage interest or charitable contributions can lower taxable income.
DI serves as a vital metric for assessing financial well-being and economic vitality. Taxes play a crucial role in shaping DI, influencing spending, saving, and investment decisions. Understanding the impact of taxes can empower individuals to make informed financial choices, optimizing their resources and maximizing their financial freedom. By employing tax-efficient strategies and leveraging available resources, individuals can effectively manage their disposable income, enhancing their economic security and prosperity. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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Filing taxes can be a stressful ordeal for many individuals, but for some, the April deadline comes too soon. If you’re one of the many Americans who filed for a tax extension, you’ve gained a little breathing room. However, it’s essential not to let that extra time slip away without acting. Here’s a guide on what to do after filing a tax extension to ensure a smooth process and avoid any potential pitfalls.
First and foremost, take a moment to reassess your financial situation. The extension deadline has given you time to gather necessary documents and reconsider certain deductions and credits. Review your financial records, receipts, and any changes in your circumstances that may impact your taxes. This step is crucial for accurate and thorough tax filing.
While filing for an extension grants you additional time to submit your tax return, it’s vital to understand the new deadline. Typically, the extended deadline falls six months after the original due date. The tax extension deadline in 2024 is October 15. Mark this date on your calendar and set reminders to avoid any last-minute rush.
Don’t fall into the trap of procrastination. Even though you’ve been granted an extension, it’s best to complete your tax return as soon as possible. The longer you wait, the more likely you are to encounter unexpected issues or delays. Aim to finalize your taxes well before the extended deadline to avoid any last-minute stress.
It’s crucial to remember that a tax extension does not grant an extension for paying any taxes owed. If you anticipate owing taxes, it’s best to estimate the amount and pay as much as possible before the original deadline to minimize penalties and interest. Failure to pay on time can result in additional fees, so make paying any owed taxes a priority.
Electronic filing is a convenient and efficient way to submit your tax return, especially if you’re working with a tight deadline. Many tax preparation software programs offer e-filing options that can streamline the process and help ensure accuracy. Additionally, electronic filing typically results in faster processing and quicker refunds, if applicable.
If your tax situation is complex or you’re unsure about certain aspects of your return, don’t hesitate to seek professional assistance. A qualified tax professional can provide guidance, ensure compliance with tax laws, and help maximize deductions and credits. While there may be a cost associated with hiring a tax preparer, the peace of mind and potential savings can outweigh the expense.
Once you’ve completed your tax return and filed any necessary paperwork, take the opportunity to plan for the future. Consider implementing strategies to better prepare for next year’s taxes, such as keeping detailed records throughout the year, exploring tax-saving opportunities, and adjusting your withholding if necessary. Planning ahead can help alleviate stress and ensure a smoother tax filing process in the future.
Filing a tax extension can provide much-needed relief for those facing a time crunch or dealing with complex tax situations. However, it’s essential to use this extra time wisely and take proactive steps to complete your tax return accurately and on time. By reviewing your situation, understanding the new deadline, promptly completing your tax return, paying any owed taxes, considering electronic filing, seeking professional assistance if needed, and planning for the future, you can navigate the post-extension period with confidence and ease. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
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