In most cases, personal injury settlements—like those from car crashes on California’s freeways, slip and falls in public places, or medical negligence claims—aren’t taxed by the IRS. If you’re asking, “Do I have to pay taxes on a settlement?”, the short answer is often no—at least when it comes to compensation for physical injuries or illnesses.
But it’s not always that simple. The IRS treats certain parts of legal settlements as taxable income, and the rules can get murky depending on what kind of damages you’re being compensated for. It also matters where you live. While federal law controls how settlements are taxed, the way state agencies—like the California Franchise Tax Board—treat those funds can vary from what you’d encounter in states like Texas or New York. That’s why it’s a smart move to talk to a CPA or tax attorney, especially if your settlement includes non-physical damages or totals in the six or seven figures. A little clarity now can save you a headache (and a tax bill) later.
Navigating the Tax Complexities of Personal Injury Settlements
Most personal injury attorneys respond to the question “Are personal injury settlements taxable?” in one of two ways:
- I’m not a tax attorney. So to acquire an answer, you need to visit a tax lawyer.
- There are no taxes levied on settlements.
Both responses may be accurate. But both have problems. The first response is accurate since you rarely have to pay taxes on settlements in personal injury lawsuits. This response might be accurate, given the case’s specific facts.
However, it is false to state that personal injury settlements are never taxed as a general, overarching concept. However, most damage or wrongful death court settlements are not subject to taxation.
The most straightforward response is to advise someone to ” hire a tax lawyer.” It entirely absolves the personal injury attorney of responsibility. The fact that it is a bonus. You can only be sure of your response by consulting a tax attorney.
The following information should not be taken as tax advice. As it turns out, neither are we tax lawyers, and you can never be confident that general counsel will apply to your situation.
However, in the actual world, people only sometimes receive conclusive responses to their legal questions. They strive to gather the most accurate information.
This article aims to arm you with the knowledge you need to decide whether you should be required to pay taxes on settlements.
When Are Personal Injury Settlement Proceeds Taxable?
Are Personal Injury Settlements Taxable? 3 How personal injury settlement money is mainly taxed depends on what you were compensated with the money and the associated tax liability. Was it, in other words, for bodily harm or illness, mental or emotional agony, or punitive damages?
Physical Injuries or Physical Sickness
Proceeds from personal injury settlements for personal physical injuries or physical illnesses are not subject to taxation. This covers bodily harm brought on by car accidents, slips and falls, work-related accidents, premises responsibility, and other incidents. It also includes physical illness brought on by things like taking dangerous prescription medicines, exposure to poisonous chemicals, or medical errors.
Because the settlement only reimburses you for the out-of-pocket costs incurred for your medical care, these revenues are often exempt from taxes.
The only exception is if you previously claimed itemized deductions for medical costs related to your injuries or illness on your tax returns. For example, imagine you suffered an injury in 2015 and received medical treatment throughout 2016. However, you did not receive your settlement until after 2016. If you claimed those medical expenses as a tax deduction for 2016, you would need to repay the taxes on that deduction once you receive the settlement that includes compensation for those medical costs.
Emotional Distress
The tax treatment of a settlement for mental or emotional suffering depends on whether a physical illness or damage is brought on by the condition. If so, this portion of your compensation is also exempt from taxes.
You’ll undoubtedly need to pay taxes on any compensation you receive for mental agony or emotional distress if it is unrelated to a medical ailment. However, you haven’t already claimed a deduction for those costs.
In that case, you can write off any medical bills you paid for your mental agony or emotional distress.
Once more, on your tax return for the period you received the settlement, you would record the whole amount of your settlement received for emotional distress or mental anguish, less your deductions for related medical expenditures, as “other income.”
Lost Wages
You must pay taxes on any compensation you get for lost wages you incur due to having to take time off work. The IRS treats this pay the same way it would handle regular earnings; thus, it is always taxable.
Punitive Damages
Punitive damages may be included in a personal injury settlement if the defendant intentionally committed an act like an assault or battery or showed a willful disregard for your safety.
Punitive damages are always taxable, whether they are awarded for psychological or bodily harm. Therefore, on your tax return for the settlement year, you must include them as “other income.”
Clauses of Confidentiality and Non-Disparagement
The parties to a settlement are forbidden from discussing the terms of the settlement and the specifics of the case. You are aware of a non-disparagement provision: it means you will keep your critical remarks to yourself.
In a case involving Dennis Rodman, of all individuals, the IRS concluded that this settlement amount is taxable. However, it’s still vital to remember.
Property Damage
In general, property settlements are not taxed. According to the IRS, even though you must reduce your property’s value by the cost of the settlement, the loss in value of the asset is not taxed if it is less than the reduced basis (if you are amortizing the property for tax purposes).
So, the difference is considered income if the settlement is more significant than your property’s adjusted basis.
But let’s pretend this is just a car you own rather than an asset you depreciate. You are unlikely to be required to pay taxes on your property damage settlement check, assuming you received a reimbursement that makes up for your loss, such as in a car accident.
Settlement Interest
Between the time the insurance or court issues it and the time you get it, your settlement may occasionally accumulate interest. If so, even if your settlement was for a physical injury or illness, you must report the interest component as income and pay taxes. Any interest earned on the settlement amount is taxable and must be reported on your tax return.
Unique non-economic damages
The IRS may also tax non-economic losses not tied to an injury. For example, if you receive compensation for emotional anguish caused by the legal procedure surrounding your case, but it is unrelated to the physical damage that prompted the action, the IRS may tax that component of your settlement.
Paying Taxes on Settlements
Settlements are taxed in the year of receipt by listing the taxable amount under “other income” on your tax return, making your personal injury settlement taxable. The IRS, however, requests that you make scheduled tax payments if you believe that your tax obligation resulting from the settlement would be greater than $1,000.
Are Personal Injury Settlements Taxable? 4 While many components of personal injury settlements are tax-exempt, some parts, such as lost wages and punitive damages, can be considered taxable income. By consulting with an experienced personal injury lawyer and tax professionals, you can navigate the complexities of your settlement and maximize your tax benefits. Always stay informed and proactive to ensure that you comply with all tax regulations and maximize the compensation you receive from your personal injury claim.
Taxes can add another layer of complexity to already complicated personal injury cases. Your worries regarding the taxes related to your settlement might be eased by working with an experienced lawyer. For more information and legal advice, contact Bojat Law Group, your trusted partner in personal injury lawsuits. Our team of experienced personal injury lawyers is here to help you every step of the way.
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