So you’ve gone through the litigation, and your personal injury attorney has accomplished securing a settlement for you the previous tax year. The question now becomes is the money entirely mine? Is the money from my personal injury settlement taxable?
As a general rule, the proceeds received from most personal injury claims are not taxable under either state or federal law. It doesn’t matter whether you settled the case before or after you filed a lawsuit with the courts or if you went to trial and won a verdict.
Not to mention, damages received as a result of your injuries or illness are excluded from a taxpayer’s gross income. So both the federal government (IRS) nor the state, can tax you on the settlement or verdict proceeds in most personal injury claims.
In Summary, as long as personal injury settlements fall under physical or emotional injuries, any compensation will remain tax-free.
What do personal injury and physical illness mean in a personal injury claim?
Personal injury damages are intended to compensate the claimant for things like lost wages, medical bills, emotional distress, pain, and suffering, loss of consortium and attorney fees are not taxable as long as they come from a personal injury or a physical sickness.
A physical illness means a claim for illness. In the case that you were negligently exposed to a germ that made you ill, any damages that you recover as a result of that illness would not be taxable. However, there are a few circumstances, depending on the type of case and the type of compensation for injuries suffered, when personal injury settlements can be taxable or partially taxable.
When is my settlement considered taxable?
The Internal Revenue Service (IRS) will only seek to tax personal injury settlements if the settlement is meant to replace your income. The following are examples of situations when a settlement may be taxed:
When Medical Deductions Have Been Performed:
If you have previously claimed medical expenses your personal injury settlement may be subject to tax.
For example, Bob Smith is injured by a defective lawn mower and has $90,000 in medical expenses. The lawn mower company settles with Bob for $90, 000. The personal injury settlement will be tax-free, and Bob does not need to report it on a tax return. But like most legal matters there are gray areas that come into play. If Bob deducted the $90,000 in medical expenses on a previous tax return, the settlement would be taxable.
Defining the Terms of Emotional Distress and Mental Anguish:
A personal injury settlement with a financial award based partially on emotional distress or mental anguish may be tax-free. If the emotional distress or mental anguish is parallel to the physical injury or physical illness, it is considered “medical” and, therefore, non-taxable.
Let’s modify Bob’s settlement case; Bob again settles with the lawnmower company for $90,000. He received $60,000 for his medical expenses due to a substantial leg surgery. Bob also receives $30,000 in compensation for mental anguish for having to live in a cast for over six months and for dealing with continuous pain. Bob’s $30,000 for mental anguish would likely be non-taxable because it is directly related to his physical injury.
In the circumstance when there is no relation between the emotional distress or mental anguish and a physical injury or physical sickness, the settlement amount is taxable.
For example, lets say you were involved in a dispute with a neighbor because he or she told the neighborhood that you stole money from the local church. These accusations turn out to be completely false, and your local business becomes ruined by your loss of reputation in the community. You can file a defamation lawsuit against the neighbor and let us pretend your case settles outside of court for $40,000. In this scenario, the entire $40,000 would likely be taxable because you suffered purely emotional and monetary damage.
An injured person may be awarded money that goes beyond ordinary compensation for injuries and is intended to punish the wrongdoer; this monetary award is taxable.
Lost wages or Loss of Income
Similar to wrongful discrimination and defamation, a settlement award with compensation for lost wages or loss of income Is taxable.
Secure your Settlement: Our lawyers at the Brown Firm can help make sure your claim remains non-taxable
Once in a while you may have two claims against a defendant, one of which relates to a personal injury and one of which does not.
For instance, especially when the personal injury claim is much higher than the non-personal injury claim, you would want to be exact and state in the settlement agreement which amounts related to the personal injury claim and what amount does not relate.
It is always advisable to speak with a personal injury attorney before you accept a personal injury settlement. The lawyers at the Brown Firm will be able to guide you in the most favorable outcome resulting your specific personal injury settlement, as well as negotiate more beneficial terms.