One of the most common questions received by any pre-settlement funding company from prospective borrowers is whether the proceeds from pre-settlement legal funding are taxable or not.
Taxes can make a big difference to personal injury victims who may be trying to eke out a means to pay the rent, keep the lights on and keep food on the table while they are unable to work and waiting for the best settlement for their case.
The bite that taxes may take out of the amount that a potential borrower is looking to borrow against the ultimate settlement of their lawsuit can make a real difference.
A borrower likely does not want to get $50,000 pre-settlement funding just to have to turn around and hand back $10,000 of that money to the Internal Revenue Service (IRS) in federal income taxes.
The good news is that, in most cases, pre-settlement legal funding is not taxable.
Bottom line: In most situations, anyone who receives pre-settlement funding is not obligated to pay taxes on that loan unless (1) the borrower uses the proceeds from the loan to make an investment that generates income or (2) the borrower’s lawsuit does not end up resolving in their favor.
General Rule About Pre-Settlement Legal Funding and Taxes
Pre-settlement legal funding is typically not taxable.
For instance, let’s say you were involved in a car accident and received pre-settlement legal funding, then the money you received will not be reported as income on your income tax return that you would then need to pay a portion of to the federal government in taxes.
The reason for this is the Internal Revenue Service (IRS) does not look at pre-settlement legal funding as wages or income like you might earn from a job or an investment.
When boiled down to the most basic concept, the IRS views pre-settlement legal funding as a loan that you will eventually repay once your case resolves through either a settlement or a jury verdict.
The Exceptions To That Rule
There are several exceptions to the general rule that pre-settlement legal funding is not considered taxable.
The first instance is if you lose your case.
If you don’t win your case, you will not be responsible for paying back the loan because pre-settlement legal funding is non-recourse. A non-recourse loan means the pre-settlement funding company does not take a stake in your home or your car or any tangible asset that they would be able to repossess or foreclose upon, like with a car loan or a mortgage.
However, the downside is if your case does not resolve in your favor through either a settlement or a jury verdict, the IRS would consider that pre-settlement advance as income. That’s because you never had to pay the capital back due to the fact that you lost your case.
The other circumstance is if you used the funds to make an investment that generated income for you.
For example, if you borrowed money against your lawsuit and then invested that money in bonds or a business that makes regular taxable payments, you would be responsible for paying taxes on whatever income you owed from those bonds or business.
The rationale behind this is that you turned the pre-settlement legal funding cash into an asset that is earning you income that you would not otherwise have had without it.
How Can Pre-Settlement Legal Funding Help You?
Although pre-settlement legal funding is mostly tax-free, not taking one out is standard financial advice. But sometimes, getting one can be an intelligent move—especially if you’re already dealing with expenses you cannot afford, and the insurance is offering you a lowball settlement amount.
Pre-settlement legal funding can help you pay your bills while your attorney focuses on reaching a fair settlement or award. You only pay it back once your case settles.
No matter what you need the money for, Baker Street Funding couples low rate lawsuit loans with excellent customer service that may help you in the here and now until your litigation successfully concludes.
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