Is Your Personal Injury Settlement Taxable?

Introduction

The federal tax laws are complex and difficult to understand under the best of circumstances, but they can be a challenge to understand and apply in personal injury lawsuits that result in a settlement or award to an injured plaintiff. Compensation received from a settlement award for out-of-pocket monetary losses for medical expenses related to the negligence of a defendant do not get reported to the IRS because they are not considered to be taxable income. It may seem simple and straightforward, but things get complicated when pain and suffering or punitive damages become part of the settlement or award.

One way to make it easier to understand how the IRS treats settlements in car accidents and other types of negligence cases is by looking at the different types of damages included in a settlement agreement reached between your personal injury attorney and the insurance company that issued a liability policy to the defendant.

Key Takeaways

Some of the key takeaways from the information provided here about income taxes on settlements is the following:

• As a general rule, settlements in personal injury lawsuits need not be reported as taxable income.
• You need to be aware of a few exceptions to the general rule that could make some of the money received in a settlement taxable.
• Working with an experienced and knowledgeable personal injury lawyer can help reduce the risk of not recognizing the taxable portion of a settlement that makes you liable for payment of interest and penalties.

Are Personal Injury Settlements Taxable?

The general answer, according to the Internal Revenue Service, is that the money you receive as a settlement of your claim for personal injuries is not taxable as income. However, there are a few exceptions you need to be aware of that could alter the general rule depending on the circumstances associated with your case.

Examples of Taxable Circumstances

The purpose of a settlement that a personal injury lawyer negotiates on your behalf with the insurance company or defense attorney for the party whose fault caused you to be injured is to compensate you for damages. Damages fall into the following categories: non-economic damages, and punitive damages.

• Economic damages: This category includes wages lost from being out of work, diminished future earning capacity, medical expenses, cost of prescription medications, and other out-of-pocket expenses that you incur because of your injuries. It also includes your claim for property damage, such as the cost to repair or replace a vehicle damaged in a car accident.
• Non-economic damages: These types of damages are quite different from economic damages and more difficult to prove. Pain and suffering, loss of companionship, loss of ability to engage in activities as you did before the accident and other types of damages that are subjective in nature.
• Punitive damages: If the conduct of a defendant was intentional or wanton and willful, punitive damages may be awarded to punish the defendant and to deter such conduct in the future. These damages are not intended to compensate a plaintiff for monetary losses or the infliction of pain or other harm.

Exceptions to the tax rules that apply to personal injury damages recovered in a lawsuit include:

• Economic damages that you recover in a personal injury lawsuit are not taxable. However, if you were wrongfully fired from a job and settled a lawsuit against your employer, the lost wages that you recover may be taxed as income by the federal government.
• If you took an itemized deduction for medical expenses related to an accident on your income tax return, you may owe income taxes on part of the settlement.
• Damages recovered for mental anguish or emotional distress may need to be reported as income unless they result from a physical injury or illness. For example, emotional distress damages awarded to family members in a wrongful death case for loss of a loved one may be taxed as income.
• Punitive damages are taxable even when recovered as part of a personal injury settlement agreement or settlement award in a personal injury case. An exception to the IRS rule about punitive damages may apply to some wrongful death settlements in those states with laws providing for only punitive damages in wrongful death cases.

If your case ends with a jury verdict in your favor and the law in your state adds interest to the judgment, the interest may be taxable. Talk to the personal injury attorney who represents you in the settlement about rules for taxability of personal injury settlements to find out how they affect you.

Do I Have To Report A Personal Injury Settlement To The IRS?

The simple answer to this question is that it depends on what damages the settlement check covers. The general rule that economic and non-economic damages recovered for injuries caused by negligence of another person are not taxable and need not be reported to the IRS applies unless a component of the settlement matches one of the exceptions.

If your settlement includes punitive damages, interest or damages for emotional harm not related to a physical injury, talk to your lawyer to confirm whether it must be reported. It is better to get professional advice than make assumptions or guess about tax laws.

Do I Have To Report Settlement Money On My Taxes?

As a general rule you do not have to report settlement money that you receive for a personal injury claim on your taxes. However, there are exceptions to the general rule, such as for punitive damages awarded for personal injuries, that may require reporting at least part of the settlement on income tax returns.

Keep in mind that the purpose of money paid to you in settlement of a claim for injuries in a car accident, slip-and-fall incident, or as a result of medical malpractice is to make you whole. Compensatory damages that essentially reimburse you for money that you paid out of your pocket contributing to making you whole as would compensation paid for the pain and suffering you were forced to endure. Money to make you whole generally does not have to be reported on your taxes.

Punitive damages, which punish a defendant, do not compensate you for a financial loss or make you whole in some way, so the IRS may consider them as income that you must report. If you are uncertain about reporting all or part of a settlement, discuss it with your attorney or tax adviser.

Conclusion

Knowing that exceptions exist to the general rule about injury settlements not being taxable may help you avoid incurring interest and penalties with the IRS. If you receive money for settlement of a non-injury claim, get legal advice from your attorney or taxation advice from an accountant.

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