When you’re successful in recovering money from your personal injury lawsuit, it is a huge relief. You will no longer need to worry about how you will pay your bills that piled up after another person’s negligent acts caused your injuries.
While this may be a major victory, you should make sure you are prepared when it comes time to pay taxes. Many personal injury victims wonder, “Are personal injury settlements taxable?”
The King Law Firm, a leading personal injury law firm, focuses on representing personal injury cases and can provide you with legal advice on the taxable income from your personal injury settlement. This blog post explores the tax implications for personal injury settlements to give you a comprehensive understanding of whether they are taxable or tax exempt, to help you make an informed decision.
What Part of a Personal Injury Settlement Is Taxable?
The answer to the question, “Are personal injury settlements taxable?” will depend on the specific details of your personal injury case. These general tips can help you understand which parts of your personal injury settlement may be subjected to taxes as per the guidelines set by the Internal Revenue Service (IRS).
Compensation for Lost Wages
The IRS considers your personal injury settlement taxable when you receive compensation for lost wages. The logic behind this is that if you were working, your gross income would be taxable income. Any lost income you recover in your personal injury settlement is then taxable as per your taxable income bracket you are in, just like other income, as it is considered as your earnings.
Punitive Damages
If the judge or jury awarded punitive damages in your personal injury claim, then these are considered taxable. They are not considered to be related directly to your personal injuries or losses.
Medical Expenses
The medical expenses awarded to cover your medical bills are often not taxable, though it will depend on your individual case. In many instances, the medical costs are taxable in personal injury settlements if you covered them for over one year or if you included an itemized deduction for the tax benefit of your medical expenses to these taxes in a previous year.
Pain and Suffering
In California, pain and suffering or emotional distress are not taxable if they are the result of physical injuries you sustained. If they are because of a non-physical injury though, meaning that you did not sustain a physical injury and only suffered emotional distress, then it is taxable. You will need to report it to the IRS and the state.
This list of taxable personal injury settlements is merely a guideline to help you gain a better understanding of your tax liability. Does the IRS tax personal injury settlements? It does, though not all of the components of your settlement money will be taxed. It helps to discuss your unique circumstances with your personal injury lawyer as well as a tax professional.
Non-Taxable Portions of Personal Injury Settlements
Some of your personal injury settlements may require you to pay taxes. However, many compensatory damages are non-taxable, meaning they are typically tax exempt.
Personal Physical Injuries
When you have physical injuries, such as in a car accident, you do not have to pay taxes on the compensation. Settlements that relate to physical illness or physical injury allow you to receive the full amount without tax deductions, and you will not need to report it on your income taxes.
Emotional Distress Related to Physical Injury
As mentioned previously, the majority of personal injury lawsuits involve a personal physical injury that also causes pain and suffering. These compensatory damages are added to your economic losses, and any compensation you receive for physical pain from an actual injury is not taxable. If you endured physical harm from another person and suffered emotional distress, you do not need to report these earnings to the State of California or the IRS.
Property Loss
Financial compensation for any property loss or property damage in lawsuit settlements is not taxable. The only exception is when the amount awarded exceeds the estimated loss of value of the property.
Wrongful Death Damages
All settlements awarded to surviving family members in wrongful death cases are completely tax free. If you lost a loved one and sued for wrongful death, you are entitled to keep the full amount awarded.
Other Things to Understand When Settling a Personal Injury Case
When you have compensatory and punitive damages and are trying to make sense of what you need to pay taxes on and what you don’t, additional factors can impact the settlement amount.
Medical insurance is a prime example, as your insurer may have put a lien on your settlement funds to reimburse them for the costs they paid. If you have outstanding medical bills, your settlement check may be used to pay these costs.
Another consideration is how you receive your settlement funds. You have the option to take periodic payments, known as a structured settlement, or a lump sum. The IRS states that damages for an actual injury or wrongful death are excluded, but the rest of the investment income from a lump-sum settlement can be fully taxable.
The future payments of a structured settlement are free from federal and state income taxes. They are also free from taxes on interest, dividends, and capital gains. In order to fully understand what is taxable for your settlement, you must discuss it with your attorney and your accountant.
How Your Attorney Can Help You with Income Tax in a Civil Lawsuit
If you are in the middle of a lawsuit in California, it is imperative to know that the money you receive may be subject to taxes. It would be a horrible experience to find out that you have accidentally mishandled your taxes after receiving your settlement.
Your personal injury lawyer can help you see which parts of your settlement are taxable and find ways to minimize the impacts. You may be able to allocate more of the funds towards your actual injuries rather than punitive damages or negotiate with the at-fault party to have them pay any taxes due. Get clear answers about your individual tax situation by contacting The King Law Firm.