Reporting Lawsuit Settlements

Whether you have to pay taxes on a settlements from a investor class-action lawsuit depends on why you got the money.

In the I'm-mad-as-hell-and-I-won't-take-it-anymore category, more and more investors burned by stock market losses are joining class-action lawsuits against the companies.

But what if you get a settlement from such a suit? Is this money taxable?

The answer depends on why you got the money. If, for example, it was because you were overcharged for a stock -- because the price was artificially high because of accounting shenanigans (or worse), for example -- the payment is seen as a refund of part of that price. So, if you still own the securities, you should reduce your basis to reflect the payment, and there's no tax consequence until you later sell the stock.

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If you've already sold the shares, however, you're supposed to report the payment as a capital gain on Schedule D for the year you get the check.

But, if any part of the settlement was for punitive damages, that money is taxable as ordinary income.

And, if part of the payment represented interest earned on the settlement before it was paid out, that's interest income.

The settlement agent should be able to help you sort out things.

Kevin McCormally
Chief Content Officer, Kiplinger Washington Editors
McCormally retired in 2018 after more than 40 years at Kiplinger. He joined Kiplinger in 1977 as a reporter specializing in taxes, retirement, credit and other personal finance issues. He is the author and editor of many books, helped develop and improve popular tax-preparation software programs, and has written and appeared in several educational videos. In 2005, he was named Editorial Director of The Kiplinger Washington Editors, responsible for overseeing all of our publications and Web site. At the time, Editor in Chief Knight Kiplinger called McCormally "the watchdog of editorial quality, integrity and fairness in all that we do." In 2015, Kevin was named Chief Content Officer and Senior Vice President.