Introduction

Ever wondered what happens if you crowdfund a lawsuit, sell your right to a legal claim, or assign your interest in a court award to someone else? These situations are popping up more as lawsuits get expensive and creative funding options grow. But what about taxes? Who gets taxed, when, and how much? In this guide, you’ll learn what assigned award interest tax means, how crowdfunded or sold legal claims are taxed, and practical steps to help you stay compliant with the IRS.

What Are Assigned Award Interests?

Let’s start simple. An assigned award interest is when someone transfers their right to receive money from a lawsuit or legal settlement to someone else. It sounds straightforward, but the details can get complex quickly.

Picture this: Someone is in a long legal battle. To keep going, they sell their claim to a litigation finance company or assign it to another person. Sometimes, friends, family, or even strangers chip in through crowdfunding. Whoever takes over the right (the “assignee”) stands to receive money if the case is successful. But the IRS still wants its share, and that’s where things get tricky.

Common Situations: Crowdfunding, Selling, and Assigning Claims

People assign award interests in a few main ways. Sometimes, a person can’t afford to keep fighting a lawsuit, so they sell their claim to a company or investor. Other times, they use platforms like GoFundMe or Kickstarter to raise money for legal expenses. In some cases, businesses assign their right to a legal settlement to another company as part of a larger deal, like a merger or acquisition. Each of these scenarios creates different tax issues and reporting requirements.

Let’s break it down with examples. Imagine Jane is fighting a wrongful termination lawsuit but runs out of cash. She sells her right to any future settlement to a litigation finance firm for $15,000. If she wins, the firm collects the settlement. Or, suppose Tom uses a crowdfunding site to raise $25,000 for a business lawsuit, promising supporters a percentage of the award. Both Jane and Tom have assigned part or all of their future settlement to others, and the IRS will want to know who gets taxed when the money arrives.

Assigned Award Interest Tax: The Basics

Here’s the big question: If you assign your right to a legal award, who gets taxed on the money? The IRS usually treats legal settlements and awards as income under Section 61 of the tax code. When you assign your interest, things can get complicated. The IRS doesn’t ignore assignments. Instead, it looks at who actually holds the right to the money at the time the award is paid out.

If you sold or assigned your claim, you might owe taxes in two ways. First, you could owe tax on the money you received when you sold your claim (this is usually seen as a sale, not a gift). Second, if you kept part of the award or received additional payments later, those could also be taxed. If you’re the assignee (the person who bought or was given the claim), you’ll need to pay taxes on any money you receive, minus what you paid for the claim and any related expenses.

Why the Assigned Award Interest Tax Matters

Assigned award interest tax matters because it directly affects how much of your settlement you actually keep. Failing to report things correctly can lead to IRS penalties, extra taxes, or even audits. The rules are in place to stop people from dodging taxes by simply transferring their rights to someone else. Even if you think you’re just helping a friend or raising funds for a good cause, the IRS expects everyone to report their share.

Misreporting assigned award interests can also cause headaches for everyone involved. Imagine a group of crowdfunders expecting a payout, only to find out taxes weren’t handled properly. That’s a mess you want to avoid.

How Crowdfunded Award Interests Are Taxed

Crowdfunding for legal claims is a new and growing trend. Maybe you set up an online campaign to help cover legal bills and promised supporters a share of a future settlement. Or maybe you contributed to someone else’s campaign, hoping for a return if they win. The tax rules here depend on exactly what was promised and how the campaign was structured.

If the campaign is purely a gift (no one expects anything in return), the IRS usually treats the money as a non-taxable gift to the person raising funds. But if you promised supporters a share of any future award, your agreement creates an assigned award interest. That’s when things get more complicated.

Say you run a campaign and raise $30,000 by promising backers 15 percent of any settlement. When the award comes in, you’ll likely need to issue tax forms (like 1099s) to each supporter who gets a payment. You’ll report the full award as income on your taxes, then deduct the amounts paid to your supporters. Each supporter must then report their share as income, and the IRS will expect everyone to keep records.

If you’re a supporter, it’s important to know that your return depends on the legal outcome. If the lawsuit fails, you might lose your money, and you likely won’t get a deduction for the loss. If the case wins and you receive a payment, that’s generally taxable income.

Award Assignment Taxable? Breaking Down the Details

The question “Is award assignment taxable?” comes up a lot. In most cases, yes. Assigning your interest in a lawsuit or settlement is seen by the IRS as a financial transaction. If you sell your claim, what you get is often taxed as income, or as a capital gain if the claim is considered an investment asset. If you assign your interest without getting paid (like giving it to a family member), you might trigger gift tax rules or other reporting requirements, especially if the award is large.

The IRS will look at the facts. Was money exchanged? Was there an agreement? Did someone get a share of the award in return for something? The answers determine the tax treatment.

How Sold Claims Are Treated for Tax Purposes

Selling your legal claim, sometimes called “sold claim taking”, is catching on, especially in bigger lawsuits. You get cash up front, and the buyer takes the risk and reward if a settlement comes in. But the tax side isn’t always simple.

If you sell your claim, the money you receive is usually taxed as a sale. If your claim was a business asset or involved lost profits, you might owe capital gains tax. If it was a personal claim, like a personal injury settlement, you might owe regular income tax. The details depend on the type of claim and what you’re selling.

For the buyer, it’s different. The amount they get from the settlement is considered income, but they can subtract what they paid to buy the claim and any associated costs. If the buyer is a company, this is handled as part of business income and expenses. If the buyer is an individual, things get more complicated, and it’s wise to seek professional advice.

Let’s look at an example. Suppose Sue sells her business lawsuit claim for $20,000. She reports that $20,000 as income or capital gain (depending on the claim type) on her tax return. The buyer later collects $60,000 from the settlement. The buyer reports the $60,000 as income, subtracts the $20,000 purchase price, and subtracts any costs to collect the award.

Litigation Finance Award: Special Tax Considerations

Litigation finance is when a company or investor gives you money to fund your lawsuit in exchange for a share of any future award. The tax rules here depend on the details of the agreement. Usually, the money you get up front isn’t taxable because it’s seen as a loan. But if you win and pay a share of your award to the investor, that payment is treated as income to the investor and a deductible expense for you.

It’s important to look closely at your agreement. Some litigation finance deals are structured as loans. Others are more like investments, where the funder owns a piece of the award. In some cases, if you lose the lawsuit and don’t have to repay the advance, the IRS could consider the original payment as income. Each situation is different, so ask for professional guidance.

Reporting Assigned Award Interests on Your Taxes

Reporting assigned award interests on your taxes can feel overwhelming, but it’s manageable if you stay organized. The key is understanding who needs to report what, and when.

If you assigned your interest, sold your claim, or received crowdfunded support with a promise of repayment, you need to:

  1. Keep clear written records of every transaction and agreement (including emails, contracts, and receipts).
  2. Report the money you received from selling or assigning your claim as income (or capital gain, if it applies).
  3. If you pay out part of your settlement to others, report the full amount you received, then deduct what you paid out (and issue 1099s to anyone who gets $600 or more, as the IRS requires).

If you are the person who bought or was assigned the claim, you’ll need to report the full amount of any award you receive, minus what you paid for the claim and any legal or collection costs. If you invested in someone else’s lawsuit through crowdfunding, you may need to report any money you get back as income, depending on the agreement and the amount.

Here’s a quick tip: If you’re not sure how to report a transaction, it’s better to ask a tax professional now than to fix mistakes later.

Common Mistakes to Avoid

Handling assigned award interest tax can trip up even careful people. Here are some mistakes to watch out for:

  1. Not keeping detailed records of contributors, promises, and amounts involved.
  2. Failing to report the income from selling or assigning a claim on your tax return.
  3. Not issuing the right tax forms (like 1099s) to others who get a share of the award.
  4. Treating the entire award as “tax-free” because it came from a lawsuit. Not all settlements are tax-free, awards for lost wages, business losses, and most punitive damages are usually taxable.
  5. Overlooking state taxes. Many states have their own rules, and you might owe state income tax even if the federal rules say otherwise.
  6. Assuming that small crowdfunding amounts don’t matter. Even small amounts can trigger reporting if you promised a share of the award.

Practical Examples: What Assigned Award Interest Tax Looks Like

Let’s walk through a few more examples to make things concrete.

Suppose you’re in a personal injury lawsuit and can’t afford the legal bills. You sell your claim to a legal finance company for $10,000. Later, they win $50,000 from the case. You’ll owe tax on the $10,000 you received, either as regular income or, sometimes, as a capital gain. The finance company pays tax on the $50,000, minus the $10,000 they paid you and any other legal costs they paid along the way.

Or say you crowdfunded $20,000 to pay your legal bills and promised funders 10 percent of any future award. If you win $100,000, you pay $10,000 (10 percent) to your funders. You’ll need to report the full $100,000 as income, then deduct the $10,000 you paid out. Each funder will need to report their share as income, and you may need to issue 1099 forms if their share meets IRS thresholds. If you forget to do this, both you and your funders could face penalties.

If you assign your right to a legal settlement to a family member without getting paid, you could run into gift tax rules. For example, if you assign a $100,000 settlement to your sibling, you may need to file a gift tax return, and your sibling will need to report the award as income. The IRS sets yearly limits on gifts before taxes kick in, so check those rules carefully.

Another scenario: Imagine a local business assigns its right to a future settlement to another company as part of a larger business deal. The business that receives the award must report it as income and may owe both federal and state taxes, depending on the type of settlement and the business structure. If the assignment was part of a merger or sale, there could be additional capital gains tax issues.

Finally, let’s look at what happens when litigation finance is involved. Suppose an investor funds your lawsuit by advancing you $25,000, to be repaid only if you win. If you lose, you don’t repay the advance, and the IRS might treat the $25,000 as income. If you win and pay the investor $50,000 from your settlement, you deduct the $50,000 as an expense. The investor reports $50,000 as income, minus their $25,000 investment and any other related costs.

These examples highlight why it’s so important to document every step and understand your particular situation before the money comes in.

How to Stay Compliant and Avoid IRS Trouble

Assigned award interest tax can be a minefield, but you don’t have to navigate it alone. Here are key steps to make things easier and safer:

  1. Before assigning, selling, or crowdfunding your claim, talk to a tax professional who understands legal settlements and assignment rules. Not every accountant is familiar with these situations, so find one with relevant experience.
  2. Get every agreement in writing. Spell out who gets what, under what conditions, and who is responsible for reporting the income. Don’t rely on verbal promises or handshake deals.
  3. Keep thorough records of every payment, agreement, and communication. Use digital files, cloud backups, or even a simple spreadsheet to track contributions, payments, and tax forms.
  4. When you receive an award, work with a tax advisor to make sure you report it correctly, deduct any amounts paid to others, and issue required tax forms (like 1099s) to anyone who receives a share.
  5. Don’t assume lawsuit awards are always tax-free. Many types of settlements (like those for lost wages, business claims, or punitive damages) are fully taxable, while others (such as awards for personal physical injuries) might be partly or fully tax-free.
  6. Watch out for state tax rules. Some states treat lawsuit settlements differently than federal rules, and you may owe additional reporting or taxes at the state level.
  7. Be aware of IRS deadlines and thresholds. For example, 1099 forms are usually due by January 31. Missing deadlines or amounts can trigger penalties.

Conclusion

Assigned award interest tax can be complicated, but understanding the basics helps you avoid costly mistakes. Whether you’re selling a claim, assigning your interest, or using crowdfunding to fund your legal fight, the right knowledge and good records make all the difference. If you have questions or need help, contact us today for expert tax guidance on legal settlements and award assignments. Don’t let confusion or paperwork keep you from getting your share.