When you’ve been affected by someone else’s actions and ended up being hurt and suffering personal injury damages, a personal injury settlement is meant to work as a way to undo the damage and put you in the position you would have been in if the incident had never occurred.
But do you need to worry about paying taxes on the money you received as a settlement? Our attorneys explain when a personal injury settlement may be subject to taxes and what to do if you need help.
What Is Included in a Personal Injury Settlement?
Most personal injury settlements include compensation for standard damages, which are economic and non-economic damages resulting from the event that led to an injury (such as a car accident or a slip-and-fall injury due to someone else’s negligence).
Economic damages are financial losses and expenses resulting from the accident and can include medical bills, lost wages, and the cost of repairing or replacing damaged property. For example, if you were hurt in a car accident, economic damages may cover your hospital bills and the cost of replacing your vehicle.
Non-economic damages cover the more subjective impact of a car accident and can include payment for pain, suffering, and emotional distress due to the accident, injury, and recovery process. In addition, some cases may allow for the plaintiff to recover punitive damages, which is additional compensation the defendant is required to pay on top of standard damages. Punitive damages may be available in cases involving gross negligence and act as a way to punish the defendant for their behavior.
Do I Have to Pay Taxes on My Personal Injury Settlement?
If you have received a significant lump sum as a result of a personal injury claim or lawsuit, it is important to know whether the money you received is taxable. The good news is that at the federal level, money received from a personal injury settlement is not counted as gross income and, thus, is not taxable.
According to section 104 of the Internal Revenue Code, “(…), gross income does not include (1) amounts received under workmen’s compensation acts as compensation for personal injuries or sickness; (2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.”
However, if you claimed an itemized deduction for medical expenses related to your personal injury claim and received money from the Internal Revenue Service (IRS) for those deductions, you may have to pay taxes on the portion of your settlement meant to cover those medical expenses. For example, if you claimed $4000 in medical expenses in your tax return and received a refund based on those expenses, you may have to declare $4000 of your settlement as taxable income.
It is also worth mentioning that most personal injury settlements are generally not taxed at the state level. However, each state has different laws and exceptions, so you may want to consult the tax laws of your state to check whether you owe any taxes on your settlement.
Exceptions in Taxability for Certain Types of Damages
When people receive a settlement for personal injury, they often wonder – are injury settlements taxable? They might assume that all of the money is theirs to keep without worrying about taxes. In many cases, that is true, but there are important exceptions. The IRS makes distinctions between different types of damages, and not everything is exempt from taxation.
Based on personal injury settlement tax rules, compensatory damages for physical injuries or illnesses are generally not taxable. If the settlement covers medical expenses, pain and suffering related to those injuries, or any direct costs associated with treatment, those amounts can usually be excluded from taxable income for personal injury claims. However, if medical expenses were previously deducted on a tax return, then that portion of the settlement might be taxable when reimbursed.
On the other hand, emotional distress can be treated differently. If the emotional suffering stems from a physical injury, the settlement is often tax-free. But if it is purely mental anguish with no physical harm involved, then the IRS may consider it taxable income. This distinction can make a big difference in how much of the settlement needs to be reported.
Punitive damages are another category that does not qualify for exemption. These are payments intended to punish the responsible party rather than compensate for actual losses. No matter the reason they are awarded, punitive damages are always considered taxable income.
Lost wages are another taxable exception. If a person receives money to make up for income they would have earned from their job, that part of the settlement is treated just like regular wages. It is subject to the same taxes that would have applied if the person had been able to work and earn that money normally.
Interest on settlements is also taxable. Sometimes settlements are not paid out immediately, and they may accumulate interest while waiting for disbursement. Any interest earned on that amount is considered taxable income, just like interest from a savings account.
Are Punitive Damages or Wrongful Death Settlements Taxable?
As explained above, punitive damages are meant to punish the defendant in a personal injury case when that person’s actions could be considered gross negligence. Punitive damages are paid in addition to standard damages and may be counted as taxable income. This is because the main objective of this category of damages is to punish egregious behavior rather than compensate the victim. In practical terms, it results in additional compensation for the plaintiff on top of whatever else they have received to make themselves “whole” and may therefore be subject to taxation.
On the other hand, a wrongful death claim is meant to compensate the surviving relatives of a personal injury victim for the losses resulting from their loved one’s accident, injury, and death. A wrongful death settlement includes compensation for medical bills, funeral expenses, lost wages, loss of consortium, and pain and suffering the decedent may have endured during the accident.
While no amount of compensation can make up for the loss of a loved one, the compensation given to relatives of a wrongful death victim is supposed to be a way to make them whole, i.e., to put them back in the state they were before the accident. For these reasons, wrongful death settlements are typically not taxable at the federal level and are usually paid to the decedent’s estate. As always, check the laws applicable to your state to determine whether any taxes are owed.
What Should I Do if I Am Still Not Sure About Paying Taxes on My Settlement?
It is normal to feel a bit confused about whether you owe any taxes on your settlement or not since the laws may be full of exceptions and difficult to understand. However, the last thing any personal injury plaintiff wants is to find themselves in trouble with the IRS after all they have endured. It is always best to talk to your attorney about any questions you may have, and you may also want to consult a tax professional.
If you have been hurt in an accident caused by someone else, the legal team at Armada Law is ready to help you fight for your rights. Our team serves injury victims in South Carolina, North Carolina, and Georgia. Reach out to our office and request a free case review.
Tips For Ensuring Compliance With Tax Obligations
Staying informed and taking proactive steps can make a significant difference in ensuring compliance with tax obligations. One key step is keeping detailed records. Documentation matters when dealing with taxes, and having organized records of the settlement agreement, medical expenses, and any related financial transactions helps ensure accurate reporting. Keeping all relevant paperwork readily accessible can prevent confusion when tax time arrives.
It is also important to set aside money for any taxes that might be owed. While some parts of a settlement may be tax-free, others could require payment to the IRS. Preparing for that possibility by budgeting accordingly can prevent financial strain. No one wants to be caught off guard by an unexpected tax bill.
Seeking professional advice early is another smart move. Consulting a tax expert can help clarify any uncertainties and ensure compliance. Laws can be complicated, and having an experienced professional review the details can provide peace of mind. A knowledgeable advisor can also suggest ways to legally minimize tax liability, helping clients keep more of their settlement funds.
Being proactive and informed is the best approach. By taking the right steps and working with professionals when needed, settlement recipients can ensure they meet all tax requirements without unnecessary complications.
How Armada Law Can Assist With Tax Queries In Settlements
Dealing with the tax implications of a personal injury settlement can feel overwhelming. With different rules applying to various types of compensation, it is easy to get confused about what is taxable and what is not. That is where Armada Law can step in and offer much-needed clarity.
Armada Law understands how tax laws apply to settlements and can help clients navigate the details with confidence. Whether it is determining which portions of a settlement are taxable or ensuring that all necessary documentation is in order, our team provides guidance tailored to each case. We take the guesswork out of the process, making sure no important details are overlooked.
Tax laws can change, and their complexities mean that even small mistakes can lead to unexpected tax liabilities. Armada Law stays up to date with the latest regulations, helping clients avoid costly errors. We provide clear explanations, breaking down legal jargon into simple terms so that clients fully understand their obligations. Our goal is to make the process as smooth and stress-free as possible.
Beyond just explaining the tax aspects, Armada Law can also work alongside financial advisors or accountants to ensure that everything is properly handled when filing taxes. This collaboration helps prevent surprises down the road and ensures that settlement recipients remain in compliance with tax laws. By having experienced professionals involved, clients can focus on moving forward with their lives rather than worrying about financial complications. To learn more about whether personal injury settlements are taxable or not, please contact us to schedule a consultation with our personal injury lawyer.
