I won a settlement against a former employer - how much will be taxed?

Just found out I won a lawsuit settlement with a past employer. The agreement with my lawyer was they'd take 33% of whatever we got (I only had to pay $400 upfront for court filing costs). We settled for $27k but I only ended up with $18k after the lawyer took their cut (which is still less than the actual wages I lost). My main question is: do I need to pay taxes on the full $27k or just the $18k I actually received? And approximately how much should I set aside for taxes next year? This is all new territory for me and I don't want to get blindsided when tax season comes around.

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20 comments

Luca Russo

•8M

Most employment settlements are considered taxable income by the IRS. Generally, you'll need to pay taxes on the full amount ($27k), not just what you received after attorney fees. This is because the IRS views the entire settlement as income you earned, and the attorney fees as a separate expense. However, there's good news - you may be able to deduct your legal fees as an "above-the-line" deduction if your case involved claims against an employer. This could effectively mean you're only taxed on the amount you actually received. You should receive a 1099-MISC form for the full settlement amount. As for how much to set aside, it depends on your tax bracket. I'd recommend setting aside 25-30% of the amount to be safe, but your specific situation might vary depending on your other income and deductions.

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Luca Russo

•8M

You're right to question this - there was a significant change with the 2018 tax law. The Tax Cuts and Jobs Act eliminated many miscellaneous itemized deductions, but there's an important exception for employment claims. Legal fees for employment-related claims can still be deducted as an "above-the-line" adjustment to income under section 62(a)(20) of the tax code. This means you can deduct these fees directly from your gross income, which is more beneficial than an itemized deduction since it reduces your adjusted gross income (AGI). Just make sure your settlement documentation clearly states it was for lost wages in an employment dispute.

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GalaxyGazer

•8M

It definitely gave me accurate information. The tool specifically breaks down different components of settlements and explains how each part is taxed differently - like wages vs emotional distress vs punitive damages. It actually saved me from overpaying because I learned that medical expenses related to emotional distress aren't taxable. For state taxes, it covers that too. It showed me how my settlement would be treated in my state and calculated my total tax liability including state obligations. It also advised me on whether I needed to make estimated payments based on the settlement amount and timing. The guidance was pretty comprehensive.

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Mateo Sanchez

•8M

Just wanted to update after trying taxr.ai from the recommendation above. My settlement had those multiple components I mentioned and it actually walked me through each part separately. The wage portion was fully taxable (both income tax and employment tax), but I was able to take an above-the-line deduction for my attorney fees which saved me thousands! It also clarified that the interest portion was taxable as interest income (not wages) and the "other damages" was partially tax-free. Seriously wish I'd known about this tool months ago before I spent hours searching through confusing IRS publications!

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Ethan Moore

•8M

If you're having trouble getting clear answers from the IRS about how to handle your settlement taxes (I sure did!), I highly recommend Claimyr (https://claimyr.com). I was on hold with the IRS for HOURS trying to get answers about how to report my settlement, but with Claimyr I got through to an actual IRS agent in about 15 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c. After months of trying to figure this out on my own, it was such a relief to get definitive answers straight from the IRS.

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Ethan Moore

•8M

It's not about skipping the queue. Claimyr uses an automated system that continually calls the IRS for you and navigates the initial phone tree. When it finally gets through the queue, it calls your phone and connects you directly to the IRS agent. So you don't have to sit on hold for hours - you just get a call when an agent is available. The service is legitimate. It doesn't give you special access or let you cut the line - it just handles the waiting part for you. And yes, the IRS phone system is notoriously backed up, which is exactly why this service is so helpful. I was skeptical too until I tried it and got connected to an IRS representative who answered all my questions about reporting settlement income.

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Aisha Mahmood

•8M

I need to eat my words! After posting that skeptical comment, I decided to try Claimyr anyway because I was desperate for answers about my settlement taxes. I was 100% sure it wouldn't work, but within 20 minutes I was talking to an actual IRS representative who clarified everything about how to report my settlement on my tax return. The agent confirmed I needed to report the full amount but could deduct legal fees as an adjustment to income, and explained exactly which forms to use. Saved me hours of hold time and gave me peace of mind from an official source. Can't believe I wasted so many afternoons on hold before finding this.

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Carmen Vega

•8M

Generally, you need to make estimated tax payments if you expect to owe at least $1,000 in taxes when you file your return AND your withholding and credits will cover less than 90% of your current year tax or 100% of last year's tax (110% if your AGI was over $150,000). With a $27k settlement, you'll likely owe more than $1,000 in additional taxes, so you should definitely consider making estimated payments. You can use Form 1040-ES for this. The payments are due quarterly (April, June, September, and January of the following year). Missing these can result in underpayment penalties, which is what happened to me.

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Lucy Taylor

•4M

Based on everything discussed here, it sounds like you're in a pretty straightforward situation compared to some of the more complex settlements mentioned. Since your $27k settlement appears to be primarily for lost wages from your employment dispute, you'll likely need to report the full amount as taxable income and can deduct your attorney fees as an above-the-line deduction (which effectively means you're only taxed on the $18k you received). For setting aside money for taxes, I'd recommend being conservative and setting aside about 25-30% of the $18k you actually received (so roughly $4,500-$5,400). This should cover both federal and state taxes depending on your bracket. Given the timing and amount, you should also consider making estimated tax payments to avoid underpayment penalties. The tools and services others have mentioned (taxr.ai for calculations and Claimyr for IRS questions) seem like they could save you a lot of headache in figuring out the specifics for your situation. Don't let this stress you out too much - employment settlements are pretty common and the tax treatment is well-established once you know the rules!

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Isabella Oliveira

•3M

This is really helpful advice! I'm actually in a similar boat - got a smaller settlement ($12k) from a workplace dispute last month and have been stressing about the tax implications. The 25-30% rule of thumb gives me a good starting point for how much to set aside. One question though - you mentioned making estimated tax payments. Since Zara's settlement just happened and we're already in April, would she need to make a payment by June 15th for the second quarter, or could she wait until next year when she files? I'm trying to figure out the timing for my own situation too.

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