Lemon Law Settlements
The "lemon law" generally refers to consumer protection laws that provide remedies for purchasers of cars and other consumer goods that repeatedly fail to meet standards of quality and performance. These laws are designed to protect consumers from defective products, particularly vehicles, by requiring manufacturers to repair, replace, or refund the purchase price of the defective product.
The impact of lemon laws on income tax is not direct, as these laws primarily deal with consumer rights and product liability rather than taxation. However, there can be some indirect tax implications:
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Non-Taxable Proceeds - If the settlement is purely a refund or reimbursement for the purchase price of the vehicle, including any sales tax and registration fees, it is typically not taxable. This is because it is considered a return of capital, not income.
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Taxable Proceeds - If the settlement includes compensation for lost wages, interest, or punitive damages, those portions would be taxable. For example, if the settlement includes an amount for the inconvenience or loss of use of the vehicle, this could be considered taxable income.
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Partially Taxable Proceeds - In some cases, a settlement might include both non-taxable and taxable components. For instance, if a settlement includes a refund of the purchase price (non-taxable) and additional compensation for lost wages (taxable), only the portion related to lost wages would be taxable.
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Legal Fees – Where a consumer prevails in a claim, lemon laws generally provide for reimbursement of legal fees. These fees, whether paid directly to the attorney or reimbursed to the consumer are taxable income to the consumer and under TCJA, at least through 2025, there is no deduction for non-business legal fees.
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Refunds, Credits and Deductions: If the consumer benefited from a refund, tax credit, or deduction as the result of the original purchase of the product or vehicle, consideration must be given to how this affects other tax benefits related to the original purchase, such as:
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Depreciation,
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Sales tax deduction for large ticket items, and
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Solar, EV and other tax credits
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