The monetary award for your personal injury case does not matter whether it is a result of a court verdict or a settlement reached outside the courtroom. Ask yourself: “Does the personal injury settlement you received count as income for your tax return?”
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This Question Does Not Have a Simple ‘Yes or No’ Answer.
This is a complicated question because the Internal Revenue Service (IRS), which regulates settlements and taxes has established rules. The IRS treats settlements as multiple payments rather than one lump sum. The reason for the settlement will determine whether or not it is taxable.
Settlements for personal injury can include:
- Taxable
- Non-taxable
Taxable and Non-taxable
Most personal injury settlements that result from physical injuries and which you have not deducted on a prior tax return, are generally non-taxable. The emotional injury will also be non-taxable if the physical injury causes mental anguish. If someone is injured at work and develops depression due to not being able to work, then they can be compensated because the mental anguish was directly caused by their physical injury.
Although this is true in general, it’s ultimately up to the IRS to decide if your settlement qualifies for non-taxable income depending on the details of your case.
What Parts of a Personal Injury Settlement May Be Taxable?
Taxation is influenced by the details of your case!
Consider the most common settlement components and how they are classified by the IRS to better understand which portions may or may be taxed. They will determine their tax status
Taxable Income and Medical Bills
When determining if a settlement is tax-deductible, there are two rules to follow.
1) Settlements for personal injury resulting from illnesses and physical injuries are generally non-taxable. The IRS taxes them only if they intend to replace your income.
2.)If you have already claimed medical deductions for the injury or illness that led to your settlement under tax laws, then your settlement will be taxable. This is because you’ve already claimed that money in a prior tax return.
Punitive Damages
The court has the right to award punitive damages. A judge or jury can set punitive damages to punish a defendant for outrageous conduct or harm. Punitive damages almost always have to be taxed.
Punitive damages are often awarded by courts, particularly in cases that have been widely publicized. Judges award punitive damages when they see a pattern of behavior that is harmful and unacceptable to the community.
Taxation is imposed even if punitive damages are a result of or related to physical injury, illness or disease. Tax returns include punitive damages under the other income heading.
Make sure your attorney examines the settlement to make filing easier. What is the difference between punitive and compensatory damages?
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Settlement Interest
Imagine you invested all or part of the money you received as a settlement. Interest is usually taxable.
Emotional Distress
Emotional distress or mental anguish is the pain caused by a traumatic experience, such as a bodily injury.
The award will be taxable if it is related to the settlement.
In general, if you suffer mental anguish as a direct result of physical injury, the compensation that you receive is not taxable. In this situation, the court may treat emotional distress in the same way as the rest.
What Is the Tax I Should Expect to Pay on a Personal Injury Settlement?
Your settlement could be taxed in whole or in part. You must report the following as “ordinary income” to the IRS when you file your taxes.
- Interest on settlement amount
- Emotional distress that is not related to physical injury
- Punitive damages
Fees for attorneys where gross income is included as the basis of recovery. And awarding damages for claims other than injury, such as a breach in contract
It’s important to consult a personal injury attorney because parts of your settlement could be taxed without you knowing. The lawyer will explain to you all relevant issues and assist in minimizing your tax burden.
Tax Tips for Personal Injury Settlements
Here are a few tips to help you reduce your tax bill.
- Consider what you want to receive before the settlement and list your settlement. You and the IRS will be able to identify your taxable income.
- Set aside any awards resulting from physical injuries after the settlement.
- It may be possible to split the settlement over a longer time period. You can lower the tax owed on certain taxable parts of the settlement.
- Consult with a professional regarding the investments you make using the money awarded by the settlement.
- If necessary, speak with the IRS. You will be able to understand your tax obligations, and avoid penalties.
A tax accountant and an experienced lawyer can guide you through this complicated issue. You don’t need to pay heavy fines if you are suffering from a personal injury. Consult an experienced tax accountant and lawyer before or as soon as you receive any compensation for your personal injury settlement. This will help avoid future complications with filing taxes.
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