Are Personal Injury Settlements Taxable?
Few dollars that we put in our pockets come without tax implications, and the money an injury victim receives in a personal injury lawsuit is no different. Whether you obtain compensation for your injuries and losses through settlement or a judgment after trial, you need to understand what the government expects to get as its cut. Failure to account for tax obligations after getting your much-deserved compensation can lead to yet more losses arising from your accident and injuries.
Different Types of Damages Have Different Tax Implications
The first thing to understand about the taxability of compensation is that the money obtained by the injury victim is allocated to different types of losses. When working with a personal injury lawyer in Lake County, for example, damages in your case may include compensation for:
- Medical costs
- Property damage
- Lost wages and loss of future earning capacity
- Pain and suffering, emotional distress, and other “non-economic” damages
The Internal Revenue Service (IRS) and the Internal Revenue Code treat these different damages differently for tax purposes.
Most Compensation From a Personal Injury Lawsuit Is Non-Taxable
Under federal law, injury victims who receive money damages either through settlement or judgment do not have to pay federal taxes on that portion of the settlement or verdict that compensates them for their physical injuries. Specifically, 26 USC § 104 provides that damages related to physical pain and suffering, including emotional distress and mental anguish arising from physical injuries, are non-taxable.
Awards and Damages for Medical Costs
If a portion of your settlement or award is for personal physical injuries and you did not take an itemized deduction for medical expenses related to the injury in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income. This makes sense, because damages for medical expenses are awarded to reimburse an injury victim for out-of-pocket expenses they have already incurred or go directly to the doctors, hospitals, and other providers to compensate them for their services.
However, according to the IRS, you must include in income that portion of the settlement or award for medical expenses you deducted in any prior year(s) to the extent the deduction(s) provided a tax benefit. In addition, if part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro-rata basis the portion of the proceeds for medical expenses to each of the years you paid medical expenses.
Compensation for Property Damage
Similar to awards for medical expenses, property damage awards often reimburse a personal injury plaintiff for the costs of repairing damaged property, such as a vehicle. Proving that tax rules can occasionally make sense, these items are not subject to tax. Thus, it would be unfair for personal injury plaintiffs to pay taxes on amounts that put them in their position before the accident.
Compensation for Lost Wages
When you receive compensation for wages you lost due to your injuries, that amount may be taxable because the wages those damages are for would have otherwise been subject to federal and state income tax.
Judges and juries impose punitive damages on a defendant to punish them and deter them and others from engaging in similar negligent behavior in the future. They are supposed to punish and prevent. But, like lost wages, punitive damages are also subject to tax.
In many cases, personal injury compensation will include an award of interest until the settlement or judgment amounts are paid in full. Therefore, any interest accrued relating to a personal injury settlement or judgment is taxable as income.
When you have received a settlement and are unsure how the income should be taxed, it is important to consult a tax professional to comply with both state and federal tax laws.
Call Lake County Personal Injury Lawyer Kirk Moyer Today For Your Free Consultation
Kirk’s experience, skill, and tenacity have resulted in a track record of success and the recovery of substantial damages for personal injury clients in Lake County and Chicagoland. And remember, you pay no legal fees unless Kirk obtains compensation for you.
If you have been injured or lost a loved one due to someone else’s negligence or reckless conduct, please call Lake County auto accident lawyer Kirk Moyer at (847) 244-3444 to arrange your FREE initial consultation.