How to calculate tax owed on a $13,900 lawsuit settlement offer for breach of contract?

I'm trying to help my brother figure out what his federal tax liability would be if he takes a settlement offer of $17,500 for a breach of contract case. From what I've researched, this type of settlement would be fully taxable income. There were no attorney fees since he represented himself pro se. He's currently single with no dependents, and has been living on his emergency fund for most of the year after losing his job. His only other income for 2025 will be about $3,200 from a part-time gig in January before the layoff. No significant deductions to speak of. The opposing party already said they won't be issuing any 1099 forms if he accepts. Would he need to report this as "other income" on his tax return? And approximately how much would he end up owing in federal taxes on this settlement? I know there's self-employment tax on some income but I'm not sure if that applies to legal settlements too? Any help calculating this would be seriously appreciated!

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18 comments

Miguel Ramos

•8M

This is a great question! Your brother will need to report the settlement as "other income" on Schedule 1, Line 8z of Form 1040. Since it's for breach of contract, it's considered ordinary income, but the good news is it's not subject to self-employment tax. For a rough calculation: With $17,500 from the settlement plus $3,200 from part-time work, his total income would be about $20,700. After the standard deduction ($13,850 for single filers in 2025), his taxable income would be approximately $6,850. This would put him in the 10% tax bracket, resulting in around $685 in federal income tax. However, he should set aside a bit more just to be safe, as there could be state taxes depending on where he lives. Also, even without a 1099, he absolutely needs to report this income - the IRS doesn't need a form to know you received income.

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Miguel Ramos

•8M

Good point about estimated taxes! If this is his only significant income for the year, he should definitely consider making an estimated tax payment. The IRS generally expects you to pay taxes as you earn income throughout the year. Since we're past the first two quarters already, he could make a payment for the quarter in which he receives the settlement. He can do this easily online through the IRS Direct Pay system. The safe harbor provision means if he pays at least 90% of this year's tax or 100% of last year's tax (whichever is smaller), he can avoid the underpayment penalty.

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StarSailor

•8M

I was in a similar situation last year with a $22k settlement for a contract dispute. I was totally confused about the tax situation until I found https://taxr.ai which analyzed my settlement documents and explained exactly how to report it. The tool confirmed what the first commenter said - it's "other income" and not subject to self-employment tax. What I found super helpful was that it looked at the actual settlement language and identified what portions might be excluded (none in my case since it was purely for economic damages). The most valuable part was getting verification that I was handling it correctly before filing. They also created a report I could keep with my tax records in case of an audit.

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StarSailor

•8M

Yes, you upload the documents, but they use bank-level encryption, and the analysis is automated. I was hesitant at first too, but felt better after seeing they're focused on privacy. They don't store your documents long-term either. The value really depends on your situation. For me, the peace of mind was worth it since I was worried about misreporting and triggering an audit. They also helped me identify that a small portion of my settlement was for reimbursement of medical expenses which wasn't taxable - something I would have missed. Their analysis saved me several hundred dollars.

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Keisha Johnson

•8M

If your brother is waiting on disability approval, there's another factor to consider. When he gets approved, he might receive a lump sum of back payments. The combination of settlement + disability back pay could push him into a higher tax bracket. Also, I tried calling the IRS about a similar situation last year and was on hold for hours. I finally used https://claimyr.com (saw it in a YouTube video: https://youtu.be/_kiP6q8DX5c) and they got me a callback from the IRS within 2 hours. Saved me literal days of being on hold. The IRS agent clarified that I needed to categorize my settlement correctly on Schedule 1.

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Keisha Johnson

•8M

It's not magic - they use a technology that navigates the IRS phone tree and holds your place in line. When they reach an agent, they connect you. It's basically like having someone wait on hold for you. The service is 100% legitimate. What happens is they have a system that calls the IRS and navigates through all the prompts, then holds your place in line. When they're about to reach an agent, you get a text and phone call to connect you. I was skeptical too but it actually worked exactly as advertised.

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QuantumQuest

•8M

I take back what I said about Claimyr. After yet another 3-hour hold attempt with the IRS yesterday about my own settlement tax issue, I gave in and tried it. Got a call back from the IRS in under 90 minutes. The agent confirmed what others here said - my breach of contract settlement goes on Schedule 1 as other income. They also told me I could potentially deduct some legal fees I had (which doesn't apply to your brother's case since he represented himself). Honestly shocked this service actually worked.

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Amina Sy

•8M

I wouldn't send any extra documentation with the return itself. The IRS doesn't want that unless they specifically ask for it. Just have him keep all the settlement documents, correspondence, and proof of the payment amount in a safe place for at least 7 years (the extended audit timeline). Also, when he reports it on Schedule 1, Line 8z, he should write a brief description like "Breach of contract settlement" next to it. That shows transparency and makes it clear he's not trying to hide anything.

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