Are Personal Injury Settlements Taxable?
Typically, you do not have to pay taxes on settlements in personal injury cases. Anyone who expects to recover an award in a personal injury lawsuit should determine whether their settlement is taxable. They do not want to discover they owe taxes after spending the settlement money. They can consult a personal injury lawyer to find out if their personal injury settlement is taxable.
Determining Whether Your Personal Injury Settlement Is Taxable
The IRS allows you to exclude the settlement payment from your gross income when you file your taxes. The tax-free status applies to both lump sum and periodic payments.
Although the IRS generally allows you to exclude personal injury settlements from your taxable income, some portions or some types of settlements may still be considered taxable income. The IRS usually splits up settlements into the following categories:
- Damages for physical injuries or sickness are always tax-free.
- Damages for emotional distress and mental anguish are tax-free when linked to physical injury or illness.
- Lost wages from a personal injury settlement count as income and are taxable.
- Punitive damages are typically taxable when linked to a personal injury settlement.
Navigating the tax liabilities connected to personal injury settlement can be confusing. However, a personal injury attorney can help you understand how to maximize your personal injury settlement and determine what is taxable and what is not.
Types of Non-Taxable Settlements
Almost all personal injury settlements are non-taxable. Some of these cases include:
- Dog bites and attacks
- Motor vehicle accidents. Only the damages you recover for personal injuries from a motor vehicle accident are non-taxable. Any amount you recover for property damages would be taxable.
- Medical malpractice suits in which you recover damages for physical injury or illness caused by a medical professional’s negligence.
- Premises liability cases in which you suffered an injury from property or building neglect. For example, if you slipped on an icy walk outside a store and recover damages for a resulting injury, the amount is not taxable.
- Workplace and construction injuries.
- Defective medication cases in which drug side effects cause serious illness or injury.
- Wrongful death cases.
Getting to a personal injury settlement takes a lot of work. A personal injury lawyer can help you understand what is a good settlement offer in a personal injury case and how to reach a beneficial settlement.
Wrongful Death Claims
Wrongful death claims are personal injury lawsuits that people file on behalf of a family member who died due to a wrongful act or negligence. Family members of the deceased may recover for the loss of financial support they received from their loved one. They can also recover for any pain and suffering the deceased experienced before death, medical and funeral expenses, and loss of a future inheritance. These recoveries are non-taxable.
Workers’ Compensation Claims
If you recover a workers’ compensation award for an injury or illness that you suffered at work, your settlement is not taxable. Neither the IRS nor states tax workers' comp awards. However, the IRS has some exceptions to its rule about non-taxable workers’ comp awards. For example, when injured workers have already deducted their medical expenses from their taxable income, the workers’ comp settlement may become taxable. A personal injury lawyer can help injured workers understand when their settlement is taxable and when it is not.
Taxable Personal Injury Settlements
While most personal injury settlements are non-taxable, there are a few notable exceptions. Personal injury victims should know what types of settlements are taxable.
Social Security Disability
Some people who suffer injuries may end up with permanent disabilities. In that case, they will likely need Social Security Disability Income (SSDI) to help supplement their earnings. SSDI payments are taxable. Many people who receive disability income do not make enough money to owe taxes to the IRS. However, they might make enough money to owe taxes if they file their taxes jointly with their spouse, or if they have additional household income. When a person receives workers' compensation, their settlement may trigger a reduction in SSDI to ensure that their total benefits do not exceed a certain threshold. A personal injury attorney can work to ensure that the settlement is structured to minimize tax liability.
Settlements for Lost Wages
Many personal injury settlements include compensation for lost wages. If you were unable to work because of your injuries, you can ask for compensation for the income you lost. Wages are always taxable. The IRS treats compensation for lost income as wages and is, therefore, taxable.
Emotional Distress Cases
Some personal injury cases focus on the emotional distress caused by an incident rather than physical injuries. For example, victims of a home invasion may suffer emotional distress even if they were not physically injured. Although it is difficult, you may be able to recover damages based solely on your emotional distress, such as panic attacks or increased anxiety. Settlements for purely emotional distress damages are taxable. More commonly, emotional distress is due to a physical injury. When emotional distress damages are tied to a physical injury, the personal settlement injury, including the emotional distress portion, is non-taxable.
Punitive damages are a special category of recovery in personal injury cases. Compensatory damages are the most common type of damages in personal injury cases. They are meant to make injury victims “whole” or place them in the same position as before the injury. Punitive damages are a special type of damages that the court allows as a punishment for the party that caused the injuries. They are appropriate when the party that caused the injuries acted willfully, wantonly, or recklessly. Punitive damages are taxable in almost all circumstances.
Reaching a settlement and determining how to satisfy tax requirements is difficult. A lawyer can help you figure out what mistakes to avoid in your personal injury case and how to maximize your settlement.