Is My Personal Injury Settlement Taxable?
Most personal injury cases settle out of court. According to Black’s Law Dictionary, only four to five percent of personal injury cases in the United States are tried to a verdict. When you accept the defense attorney’s settlement offer, then the case is settled pretrial. Once you receive your settlement, you’ll probably want to know what the next step is. Just how much of your money is Uncle Sam entitled to receive? In this blog post, we’ll discuss tax issues as they apply to a personal injury settlement.
Personal injury damages refers to compensation received for lost wages, medical bills, emotional distress, pain and suffering, loss of consortium, and attorney fees. In most cases, these aren’t taxable as long as they come from a personal injury or a physical sickness.
So what’s taxable and what isn’t? Here’s the breakdown of what you can expect to be taxed on and what will be exempt from taxes once you receive your settlement award.
- Compensation for physical injury or physical sickness.
- Compensation for emotional distress due to physical injury or sickness.
- Compensation for medical expenses. If you deduct a medical expense and are later reimbursed by an award or settlement, you must report the previously deducted amount as income on your tax return for the year you receive the money.
- Compensation for lost wages due to a physical injury.
- Breach of contract suit. Even for physical injury or physical sickness if the breach of contract caused your injury, and the breach of contract is the basis of your lawsuit then it is taxable.
- Punitive damages. For punitive damages, your lawyer should ask the judge or jury to separate the verdict into compensatory damages and punitive damages so you can show the IRS which part of the verdict was for compensatory damages, since those are not taxable.
- Interest on the judgment. Any interest you receive for the length of time that the case has been pending are subject to taxes.
- Emotional injury only. This is taxable, unless you can prove even the slightest amount of physical injury.
Ensure That as Much of Your Settlement as Possible is Non-Taxable
In some cases you might be filing multiple claims against the defendant. When this happens, sometimes one is for a personal injury and another one isn’t related to a personal injury. In cases like these, especially if the personal injury claim is much larger than the non-personal injury claim, you should have the settlement agreement explicitly state which amount of the settlement is for the personal injury claim and which amount of the settlement is for the non-personal injury claim. Why? So you don’t pay taxes on any amounts that are considered tax free (such as those related to any physical injury you suffered).
When you divide your settlement like this, it provides you with the best chance of having most of the settlement excluded from taxation.
*Please note that this is general advice which may not apply to your specific circumstance. Be sure to check with your tax planner or CPA before making any decisions about your taxes.