When you receive cash from a pre-settlement funding firm like Resolution Funding, a valid concern is whether you should report that money to the IRS. A financial windfall almost always requires taxes to be paid, but settlements are a different story. Here’s a publication from the IRS that makes it clearer. The short answer: a settlement for personal physical injuries doesn’t need to be reported as income if you did not take an itemized deduction for medical expenses related to the injury in prior years. If you did take deductions in prior years (that provided a tax benefit), you will need to report part or all of those proceeds as other income.

Pre-settlement funding, however, is a little different. It acts like a loan, although it technically is not one. A person will be required to “pay back” that loan upon successful completion of litigation. Since a repayment has been intended from the outset, the IRS does not consider this a taxable item.

In the event that a case is not settled and there is no successful judgment for the plaintiff, the advance is still not taxable. Even though the advance is money that a person has gained for their personal use, it is still just a cash advance and not seen as income. Think of it like a credit card cash advance. Neither type of advance is considered income.

So, when is an advance considered taxable income? There are a couple of scenarios. If the proceeds from an advance are used in an investment fashion, any profits gained would be subject to taxation. Also, if a recipient of an advance loses their case, the advance would be considered income and the person would receive a 1099 from the settlement funding company.

Although a settlement intended to compensate you for your losses—including lost wages— is not taxable, punitive damages are. Punitive damages are intended to punish a defendant for their misconduct and deter them or others from behaving similarly again. However, it is important not to misunderstand the difference. Settlements for emotional distress, mental anguish, or lost wages must be related to a personal physical injury or physical sickness to be considered untaxable.

The taxability of settlements and pre-settlement funding can be confusing to understand and there are a number of exceptions to the rules. If you have questions, be sure to consult a CPA and your attorney.

Disclaimer: Resolution Funding Group does not provide legal or tax advice. You should always consult with attorney or accountant.