Legal settlements - Are they taxable?

Taxable proceeds

If you receive amounts from settlements or insurance proceeds as a result of engaging in a specific business activity, it is subject to B&O tax and, in some cases, sales tax. Examples may include, but are not limited to:

  • insurance proceeds
  • court-ordered payments
  • certain settlement agreements for lost business income

Payments for engaging in a specific business activity

If you receive payments after engaging in a specific business activity, taxes are based on that activity. Some examples include:

  • breach of a retail construction contract where the other party did not pay the prime contractor for their construction services rendered (retailing business and occupation (B&O) tax and retail sales tax)
  • breach of an engineering contract where the other party did not pay the engineering firm for their design services rendered (service and other activities B&O tax)
  • unauthorized use of intangible property (royalties B&O tax)

Absence of a specific business activity

If you receive payments in the absence of a specific business activity, you owe B&O tax under the service and other activities classification. Some examples include payments you received from insurance for lost business:

  • not selling ski lift tickets due to a lack of snow (service and other activities B&O tax)
  • lost business at a restaurant due to nearby road construction (service and other activities B&O tax)
  • inability to license a defective patent (service and other activities B&O tax)
  • inability to sell lost or damaged inventory (service and other activities B&O tax)

Non-taxable proceeds

If you receive payments for non-business purposes, such as personal injury or property damage (excluding inventory), you do not owe B&O tax on this income. This may also include certain insurance or other legal settlements. Examples include payments you receive:

  • to cover damage to operating assets
  • for personal injury
  • for eminent domain

Example 1

Company A receives a settlement from a lawsuit over the unauthorized use of a copyrighted photograph in a magazine. Does Company A owe business and occupation tax on the settlement funds they received?

Yes, Company A would owe B&O tax on the settlement funds. Company A would owe tax because they received a payment for the use of an intangible (albeit unauthorized). Here, Company A is in the business of selling photographs or granting licenses to use photographs. Because that is the case, they owe B&O tax on the amounts they received from the settlement under the royalties classification. See WAC 458-20-19403 for attribution methods of royalty receipts.

Example 2

Company B, an engineering firm, receives a settlement from an insurance claim for damages to its building caused by a vehicle that lost its brakes. Does Company B owe B&O tax on the settlement funds they received?

If the settlement is for lost business, they owe B&O tax under the service and other activities classification.

If the settlement is for non-inventory property damage, they do not owe B&O tax.

Example 3

Company C, a moving company, receives payment from its landlord as a result of the landlord’s breach of its real property lease with Company C. The landlord will no longer rent to Company C. Does Company C owe B&O tax on settlement funds they received for this breach?

No. Company C received the settlement amount because their landlord’s breached its lease.  This is not business income for Company C.