Wondering whether personal injury settlement is taxable is a question many people ask. Most people don’t understand the tax consequences.
A personal injury settlement serves one primary purpose. The compensation can cover an accident victim’s losses to make them whole. Compensatory losses include medical bills, lost wages, and other expenses.
The Internal Revenue Service (IRS) typically doesn’t impose tax penalties on money recovered for compensable losses. However, there are exceptions. Additionally, state-level taxes differ and are subject to separate laws.
You can pursue a personal injury case if someone else’s negligent actions cause your physical injury. For example, if you hit your head on the steering wheel and sustain a concussion after another driver runs a red light and crashes into your vehicle, it might mean the other driver was negligent. You can file an insurance claim or lawsuit to seek money for your injuries and losses.
Your injuries from the accident must be physical for the money to be non-taxable. For example, if you were paralyzed in a car accident, your medical costs and any expenses to adapt to your injury aren’t taxable. If you also experience emotional distress, as long as it is related to the physical injury, federal and state taxes won’t apply.
Your settlement isn’t subject to taxes if you experience emotional distress after an accident and it directly relates to your physical injury. However, emotional distress that doesn’t accompany a physical injury requires paying federal and state taxes on the settlement.
If you can’t return to your job or you earn less income than usual due to your injury, the portion of compensation you receive to cover your lost wages is not taxable as long as it is for a physical injury or is related to a physical injury.
The same is true for any lost future earnings. You might experience a reduction in salary from taking a different job, transferring to another position, or being unable to maintain employment after the accident. Your settlement can compensate for the difference between your wages before and after sustaining your injury. Those future lost earnings are not taxable unless unrelated to a physical injury.
Suppose you got hurt in a car crash and received reimbursement from the insurance company for repairing or replacing your vehicle or other property destroyed in the collision. In that case, you won’t have to pay taxes on your settlement as long as it is related to the physical injuries you received in the crash.
Typically, you don’t have to pay taxes on the money you receive to reimburse past and future medical expenses for treating a physical injury related to an accident. However, one exception subjects a personal injury settlement to taxes.
Since personal injury cases can take months or even years to settle, you might not have the money to cover your medical expenses. Instead, you must pay out of pocket or use your health insurance for each appointment.
You might take an itemized deduction for medical costs related to your injury before settling your case or reaching a favorable jury verdict. That requires you to claim that deduction on your tax return as other income. That portion is taxable if you previously reported deductions for those medical expenses on your tax return.
Unlike compensatory losses, the purpose of punitive damages isn’t to make someone whole. Instead, the money punishes the defendant for their wanton, reckless, or willful conduct.
Although a punitive damage award is rare, it does happen, and you should understand how it works. You must pay taxes since punitive damages differ from medical bills, pain and suffering, and other compensatory losses. The IRS considers them a type of income.
Why Taxation Should Not Deter You from a Personal Injury Case
You might think pursuing compensation for your injury isn’t worth it if you have to claim it on your tax return. However, federal and state taxes don’t apply to most parts of a settlement.
Holding someone accountable for causing an accident with a claim or lawsuit is the best way to seek the money you need to pay your medical bills, reimburse your lost wages, and compensate for the physical or emotional pain you experience. Although some losses are subject to taxes, you might walk away with a significant monetary award that financially benefits you.
Secure an Adequate Settlement with Help from a Lawyer
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