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Trying to settle a personal injury claim is overwhelming. It can be stressful to get the money that you need and deserve after your accident. One of the only things that could make it worse is worrying about the IRS and what portion of your settlement they will want.
In the United States, money that’s awarded in personal injury cases can be taxable, non-taxable, or partially taxable. Generally, this money is not taxable, but there are exceptions to the rule and a number of additional guidelines that you should keep in mind.
Ultimately, whether or not your settlement can be taxed depends almost entirely on what you were seeking damages for. Usually, if you were seeking compensation for an injury, that amount can’t be taxed; if your damages could feasibly count as additional income, be prepared to report them on your tax returns.
Let’s break down what is and is not taxable.
Regardless of whether the case was settled in or out of court, if you are getting compensated for a physical injury or illness, you are generally not subject to federal or state taxation. If you were injured on the job or exposed to something like bacteria that made you very sick, then you can receive damages. Compensatory damages are the type of damages that aren’t taxed. If you have lost wages, medical bills, attorney’s fees, or loss of consortium, you probably won’t be taxed.
Emotional distress or mental anguish damages may be tax-free, but they aren’t always. If the distress is related to the physical injury, it’s considered medical and non-taxable. A person who is suffering from physical pain as well as emotional anguish as a result of living in a cast for six months would likely be able to keep the entirety of their settlement.
There are a number of damage types that are taxable. Punitive damages used to punish the defendant in your case will count as income and be taxed. Any interest on the judgment that’s built up until the time that your settlement is paid to you is taxable as well. Lost wages and any lost income will be subject to taxation, as will any damages related to breach of contract if the breach of contract is the reason you’re going to court.
Emotional distress or mental anguish that is not the result of a physical injury or illness is taxable. If your case relates to defamation, harassment, invasion of privacy, discrimination, or wrongful termination and you receive damages, you will have to pay taxes on them—as long as you do not have a physical injury.
Think carefully about whether you want to declare your settlement as an itemized deduction for medical expenses. If you don’t declare it, you can keep the proceeds; if you deducted it in a previous tax return, it will be taxable.
Your lawyer should always ask that punitive and compensatory damages from your settlement are separated to make sure that you can prove to the IRS which damages can and cannot be collected on. We can help you with this process.
If you or a loved one have been injured as a result of someone else’s negligence, contact the Indianapolis Personal Injury Attorneys of Wilson Kehoe Winingham. The lawyers at WKW can help you get the compensation you deserve. Call 317.920.6400 or fill out an online contact form for a free, no-obligation case evaluation.