Are Personal Injury Settlements Taxable?
Individuals receiving compensation for injuries or harm resulting from accidents or any events that could have been avoided or prevented if only other individuals, groups, or entities were not negligent in their responsibilities often ask if the compensation they receive are taxable. The Internal Revenue Service provides very specific guidelines on whether or not personal injury settlements are taxable.
Generally speaking, if the settlement proceeds are not included in one’s income, the settlements are not taxable. The IRS has shown incredible restraint in not taxing settlements that are consistent with the settled claim’s inherent substance.
For physical injuries or illness
Individuals who receive payments as settlement for personal physical injuries and/or sickness are not taxed either by the federal or the state government. This is regardless of whether or not you settled the lawsuit without going to court or a lawsuit has already been filed in court. It also doesn’t matter if the plaintiff went to trial and got a favorable verdict. The settlements of most personal injury claims are non-taxable. As long as the damages are related to personal physical injury or sickness, the settlement payment is not subject to either state or federal tax. This can include compensation for lost wages, emotional distress, loss of consortium, medical bills, pain and suffering, and even attorney fees.
However, there are always exceptions to the rule. For example, if the cause of one’s personal injury is related to a breach of contract, then taxes may be imposed on the damages related to the breach of such contract. This is especially true if the lawsuit is based primarily on breach of contract.
Additionally, if the case goes to court and you are awarded punitive damages, these are always taxable. Punitive damages are intended to deter other would-be wrongdoers while punishing the defendant by awarding you money that is well beyond ‘normal’ compensation for such injuries. Punitive damages are always taxed. As such it is always important that personal injury lawyers request for the separation of punitive damages from compensatory damages. As a rule, compensatory damages are non-taxable; punitive damages are taxable.
The pendency of the case can also be meted with interest which, in turn, is taxable. For instance, if the lawsuit was filed on January 1, 2016, there is already interest of the verdict until such time that you receive payment. If the case was won at a trial on January 20, 2017, but it wasn’t until February 2, 2018 that the defendant paid, then the interest accrued from January 1, 2016 to February 2, 2018 will be added onto the total amount of the payment. This part of the payment is taxable.
For mental anguish or emotional distress
As long as the mental anguish or emotional distress can be proven to be the direct result of a physical injury or physical sickness, then payments for such damages are not taxed. However, if there is no solid evidence linking the mental anguish or emotional distress to a physical injury, then any verdict or settlement will be taxed.
For example, you may file for employment discrimination and the court may agree with you that you are discriminated against. You will be awarded damages. However, these payments will be subject to tax since there are no physical injuries to link the emotional trauma to. On the other hand, if you have mental anguish because of the severe disfigurement you sustained because of severe burn injuries, then the settlement payments you receive will not be taxed.
For the most part, personal injury settlements are non-taxable. However, there are instances or situations wherein the payments may be taxed either wholly or partially. Consult with a qualified lawyer that specializes in personal injury claims.