Why You Got a W-9 for a Lawsuit Settlement Payment

Receiving a request to complete a Form W-9, Request for Taxpayer Identification Number and Certification, after a lawsuit settlement is a standard business practice. Payers use this form to formally request your name, address, and Taxpayer Identification Number (TIN) for potential tax reporting to the Internal Revenue Service (IRS). The form itself does not determine if your settlement is taxable; it is an information-gathering tool for the paying party to comply with its tax obligations.

The Payer’s Reporting Obligation

Businesses, insurance companies, and other entities that pay settlements are required by the IRS to report these payments. To do this, they must issue an information return, such as a Form 1099, to both the recipient and the IRS. The Form W-9 is the mechanism used to gather the recipient’s correct name and TIN, which is necessary to accurately prepare the subsequent Form 1099.

A reason for the payer’s insistence on receiving a completed Form W-9 is to avoid penalties for failing to file a correct information return. If you do not provide the payer with your TIN, or if the TIN you provide is incorrect, the payer is required by law to withhold a flat 24% from your settlement payment and remit it directly to the IRS. This is a mandatory requirement to ensure tax compliance.

The payer keeps the Form W-9 for their records and uses it to prepare the necessary tax forms at the end of the year; it is not sent directly to the IRS. The goal is to have the correct information on file to properly report the payment. Complying with the W-9 request ensures you receive the full payment amount upfront, without any funds being held for backup withholding.

Determining the Taxability of Settlement Proceeds

The taxability of lawsuit proceeds depends entirely on the nature of the claim the settlement is resolving. The IRS looks to the origin of the claim to determine the tax treatment. It is possible that some portions of your settlement are taxable while others are not, and the payer may issue a Form 1099 for the total amount, leaving the allocation to you.

Payments for Physical Injuries or Sickness

Compensation received for observable bodily harm is not considered taxable income. This includes payments for medical expenses incurred to treat physical injuries or sickness. However, if you previously deducted medical expenses related to the injury on your taxes, you must include that portion of the settlement as income to the extent the deduction provided a tax benefit.

Payments for Emotional Distress

The tax treatment of damages for emotional distress depends on its cause. If the emotional distress is a direct result of a physical injury or sickness, the compensation is non-taxable. However, if the emotional distress does not originate from a physical injury, such as in cases of harassment or defamation, the proceeds are considered taxable income, though the total can be reduced by payments for related medical care not previously deducted.

Punitive Damages

Punitive damages are awarded to punish a defendant for egregious conduct and are almost always taxable. This is true even if the punitive damages are connected to a case involving physical injuries or sickness. The IRS views these payments as a financial windfall, placing them in the category of taxable income.

Interest

Any portion of the settlement that is explicitly designated as interest is taxable income. This amount is reported to you and the IRS on Form 1099-INT.

Completing Form W-9

Complete Form W-9 accurately to avoid issues like backup withholding or incorrect tax reporting. You can download the most current version of the form directly from the IRS website.

On Line 1, enter your name exactly as it appears on your income tax return. If you have a business name or are a disregarded entity, that information goes on Line 2. Lines 5 and 6 are for your mailing address, which is where the payer will send your year-end tax information statement, such as a Form 1099.

Part I of the form asks for your Taxpayer Identification Number. For most individuals, this will be your Social Security Number (SSN), but for a business or trust, you would provide the Employer Identification Number (EIN). In Part II, you must sign and date the form to certify that the TIN you provided is correct and that you are not subject to backup withholding.

Post-Submission Expectations

After you have submitted the Form W-9 to the payer, they will use that information for their year-end tax reporting. You will receive an information return in the mail for the year in which you received the payment, which is also sent to the IRS.

Depending on the specifics of your settlement, you will receive a Form 1099-MISC for miscellaneous income, a Form 1099-NEC for nonemployee compensation, or a Form 1099-INT for interest payments. Payers are required to send these forms to recipients by January 31 of the year following the payment. The form will report the gross proceeds paid, which may include both taxable and non-taxable portions of your settlement.

It is your responsibility to use this form, along with your settlement agreement and consultation with a tax professional, to correctly report the taxable income on your tax return. The Form 1099 serves as the official record of the payment, and you must be prepared to reconcile the amount on the form with the amount you report as income.