What Makes Personal Injury Settlements Taxable?
The vague feelings of dread that accompany tax season might be especially intense if you’re wondering if your personal injury settlement is taxable. Federal tax laws specifically address what circumstances make personal injury settlements taxable.
The good news is that you may not have to pay taxes on a personal injury settlement. However, the bad news is that there are a few circumstances where the IRS may be entitled to some of what you receive from the insurance company. The IRS website has more information on personal injury settlements and federal taxes.
Most Personal Injury Settlements Are Not Taxable
Settlements arising from physical injury are generally not taxed.
Settlements related to liability for physical injuries are not taxable income. This applies to most car accident victims and other personal injury plaintiffs. As long as your claim arose from physical injuries, the proceeds you receive are not taxable. This includes compensation for any damages resulting from your physical injury, including:
- lost wages
- medical bills
- attorney’s fees
- pain and suffering
- emotional distress
In general, neither federal nor state governments tax personal injury settlements or judgments. This means that even if you go to court and a jury or a judge awards you a judgment, you will most likely not pay taxes on it.
When Personal Injury Settlements Taxable
Most accident victims do not have to pay taxes on personal injury settlements.
Even when circumstances make personal injury settlements taxable, the IRS will probably not tax the whole settlement. The amount of tax is typically reduced by medical bills or previous deductions that did not result in tax benefits.
If you do have to pay taxes on your settlement, it will most likely be because you claimed some of your medical bills as a deduction for a tax benefit in a previous tax year. However, in this case, only the portion of your settlement that is compensation for those previously deducted bills is taxable; the remainder of the proceeds is not. This exception may apply to you if:
- it took you or your attorney a long time to reach a settlement agreement;
- you had to pay some of your medical bills out of pocket; and
- you took a deduction for your injury-related medical bills on your income taxes
If the person who was at fault in your accident was criminally negligent, you may have received punitive damages. Drunk driving or texting and driving are criminally negligent acts. Punitive damages make personal injury settlements taxable. If you received a large punitive award, your tax liability may be significant. This only applies to you if:
- your personal injury case went to court, and
- the jury specifically awarded you punitive damages
Interest on Personal Injury Claims
Many jury verdicts result in defendants filing appeals. In these cases, the judgment that you were entitled to during the appeals process accrues interest. The interest is paid to you along with the principal amount of your judgment. This interest is taxable as interest income. This only applies to you if:
- your case went to court;
- a jury awarded you a judgment;
- the defendant appealed the judgment; and
- a court of appeals upheld the judgment
If you were in an accident and you received compensation only for emotional distress, not for physical injuries, your settlement is taxable. This only applies to people whose emotional distress claims were not related to a physical injury. However, your tax liability for these settlements is reduced by:
- the amount of any medical bills you had to pay that was related to your emotional distress, and
- by the amount of any deductions you took on your bills that did not result in a tax benefit
Contact an Asheville Personal Injury Attorney After Your Accident
Personal injury law and tax law are both complex subjects on their own. If you have a problem that is related to both of these areas, you may be risking a lot by proceeding without the advice of an attorney.
You may want to speak to a personal injury attorney before you attempt to settle with the insurance company. This is especially important if your case involves severe injuries and high medical bills. An Asheville personal injury attorney can offer you personal injury claims advice and guidance on speaking to insurance adjusters. Call or email our office today to speak to an attorney who will evaluate your case and advise you on how to proceed. For more info, read our post on why is my personal injury suit taking so long to settle?