Friend settling lemon law lawsuit for 78K - will she have to pay taxes on settlement?

You're right to be concerned about your cousin's tax situation. Lemon law settlements are generally taxable, but how they're taxed depends on several factors. The IRS typically considers lawsuit settlements taxable income unless they specifically compensate for physical injuries or physical sickness. Lemon law settlements don't fall under this exception since they relate to product defects, not personal injuries. Your cousin will likely need to report the settlement as income, but she may be able to deduct the cost basis of the vehicle (what she paid for it). The attorney fees are a bit complicated - they're likely included in taxable income but might be deductible as a miscellaneous itemized deduction subject to limitations. I'd strongly recommend she speak with a tax professional before spending that money. The tax bill could be substantial, and it's better to be prepared than surprised.

I went through something similar with a defective truck settlement last year. I found this amazing service called taxr.ai (https://taxr.ai) that really helped me understand exactly how my settlement would be taxed. I was super confused about what portions were taxable and what deductions I could claim. They analyzed my settlement documents and gave me a detailed breakdown that saved me literally thousands. Their AI analyzed my settlement agreement and pointed out specific language that helped reduce my tax burden. They even showed me how to document everything properly in case of an audit.

I just tried taxr.ai after seeing it mentioned here and WOW! My situation was with a workplace settlement but the tax questions were similar. I was totally confused about how much to set aside for taxes. Their system identified specific language in my settlement that qualified part of it as non-taxable (something my accountant completely missed). It also caught that my attorney fees could be deducted in a way I didn't realize. The report explained everything in plain English and I feel SO much more confident going into tax season now. Definitely worth checking out for anyone dealing with settlement money. Wish I'd known about this before nearly overpaying thousands in taxes!

If your cousin is still being stubborn about getting tax advice, another issue she'll likely face is actually getting answers from the IRS if she calls with questions. I spent weeks trying to reach someone last year after receiving a 1099-MISC for a smaller settlement. I finally used Claimyr (https://claimyr.com) and it was a game-changer. They got me connected to an actual IRS agent in about 20 minutes when I'd been trying for days on my own. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c The IRS agent confirmed exactly how my settlement needed to be reported and what documentation I needed to keep. They even helped me understand which forms to use for the attorney fee deduction. Honestly saved me hours of frustration and potentially an audit.

I have to admit I was completely wrong about Claimyr. After posting that skeptical comment, I decided to try it anyway since I've been trying to reach the IRS about a missing refund for literally MONTHS. It actually worked exactly as described. I got a call back in about 25 minutes with an IRS agent already on the line. The agent was able to tell me exactly what was happening with my refund and gave me a timeline for resolution. For anyone dealing with settlement tax questions like the original poster's cousin, being able to get direct answers from the IRS is incredibly valuable. They confirmed some things about settlement taxation that my accountant wasn't 100% sure about. Definitely recommend giving it a try if you need official clarification.

Just wanted to add - your cousin should ask if the manufacturer is issuing a 1099 for the settlement. In my lemon law case last year, I received a 1099-MISC for the full amount including attorney fees. The best approach is to report the full amount on line 8 of Schedule 1 (Form 1040) as "Other Income" and then if eligible, deduct the attorney fees and car cost basis elsewhere on the return. But without that 1099, the IRS might not know about the income... though not reporting it would technically be tax evasion.

One thing to consider is whether any of the settlement is for reimbursement of expenses. If part of the settlement is specifically to reimburse her for repairs she paid for out of pocket, that portion might not be taxable since it's just making her whole (not income). Does anyone know if lemon law settlements typically break down the amounts into different categories? Like compensation vs reimbursement?

Your cousin really needs to listen to you on this one. I went through a similar situation with a lemon law settlement two years ago for about $65K, and I can confirm that the entire amount was taxable income. The biggest mistake I made was not setting aside money for taxes immediately. I ended up owing about $18K in federal and state taxes combined, plus I had to make estimated payments the following quarter to avoid penalties. The settlement felt like a windfall until tax time rolled around. What really helped me was getting the settlement agreement reviewed by a tax professional before I spent any of the money. They were able to identify which portions might qualify for different tax treatment and helped me calculate exactly how much to set aside. Your cousin should definitely ask her lawyer to clarify what they meant about settlements not being taxable - they might have been referring to a completely different type of case. Lemon law settlements are almost always taxable unless there's some very specific language about personal injury (which would be unusual for a defective car case). Tell her to at least set aside 25-30% of the settlement for taxes until she can get proper advice. Better to be overprepared than scrambling to pay a huge tax bill later.