Is a Personal Injury Settlement Taxable?

Posted in Personal Injury on May 16, 2019

In a personal injury case, the settlement offer comes before or during trial, and little else is required from you. All you need to do is accept the defense attorney’s settlement by way of phone, email, or fax – whichever method you prefer. You might think your compensation arrives shortly after that, but the truth is, after your lawyer has taken their contingency fee, the IRS might also try to take a piece.

Compensation for Physical Injury Is Not Taxable; Emotional Injury Is

The good news is, compensation for physical injury claims are not taxable under federal or state law. This applies to most personal physical injury settlements. Whether you went to trial and won a verdict; whether you settled the case before or after filing a lawsuit, laws forbid the state or federal governments from taxing your settlement. Specifically, as long as compensation is received as a direct result of personal injury or sickness, then lost wages, medical bills, and emotional distress cannot be taxed.

Unlike physical injury, a settlement for emotional injury alone is taxable. This means that any emotional distress or employment discrimination claim is taxable, unless you can relate it directly to some type of physical injury. If mental anguish and emotional distress are a direct result of physical pain, then the settlement will not be taxed. An emotional personal injury settlement can be easily awarded; however, it is also easily taxed.

Exceptions

There are exceptions to your personal injury settlement however. For example, if you took out an itemized deduction for related medical expenses in previous years, your settlement is taxable. This means you will have to claim the portion of your settlement that provided a tax benefit on your taxes. Anther example is if a breach of contract is what causes your personal injury or sickness, then you will also be taxed.

Punitive damages are highly common in these cases. These are damages awarded to punish the at-fault party, such as driving 60 mph while not intoxicated and causing a serious collision. Punitive damages are taxable, but your lawyer will typically ask the judge to clearly separate compensation into punitive and compensatory damages. If you received compensation for lost wages, due to an absence from work, if the recovery is itemized, this may also be taxed. Lastly, interest is also taxable. If you file a claim in 2012, but your settlement is not paid until 2014, you would have received two years worth of interest. This interest will be taxed.

How to Ensure as Much of Your Settlement Is Non-Taxable

If you want to receive full compensation for your personal injury settlement, there are some helpful tips to consider. First, ensure that your claims are directly related to physical injury. If you have two claims against the defendant, one physical and one emotional, and the physical is significantly more, make sure to explicitly state in your settlement agreement what portion relates to each claim. This way, only the appropriate amount and not the full settlement will be taxed.

In a perfect world, none of your personal injury settlement would be taxed. In reality, everything that is not related to a physical injury will be. Your lawyer should know the protocol when it comes to settlement taxation and will safeguard your settlement as much as possible.