Are Personal Injury Settlements Taxable?

October 1, 2020

In many cases, personal injury claims can take months or years to resolve. While these cases often result in financial compensation, keeping track of the potential tax consequences of a settlement can be difficult over that span of time.

The good news is that the vast majority of personal injury settlements are not taxable under state or federal law. The bad news is that in limited circumstances you could owe taxes on parts of your personal injury claim. If you fail to meet your tax obligations, you could face serious consequences including criminal charges.

When you work with a seasoned personal injury attorney, you get more than a lawsuit filed on your behalf. Your attorney can advise you on what aspects of your claim are taxable, and can help you take that into account when determining if a settlement offer is acceptable or not. For more information, contact the Jackman Personal Injury right away.

Forms of Compensation That Are Not Taxable

For the most part, the Internal Revenue Service (IRS) does not tax compensation obtained from personal injury lawsuits. This is because the IRS does not qualify this money as income at all. Because these monetary settlements exist to compensate you for your losses, they are at best making you whole again after an injury. The deciding factor is usually whether or not the settlement resulted from some form of “observable bodily harm.” If your injuries result in a monetary settlement, it will usually not be taxed by the federal government.

This compensation goes well beyond medical bills. Although you would have been taxed on any income you earned following your accident, you are not taxed on any compensation you recover for lost wages.

Tax law also does not differentiate between lump sum payments or installments. There is no tax advantage to accepting the full settlement up front versus taking smaller installment payments in the coming months or years. This gives you the freedom to accept the best offer without weighing your decision on an unfair tax burden.

When Taxes Can Apply to your Injury Settlement

Unfortunately, there are aspects of a personal injury settlement that could result in a tax bill. The good news is that these types of damages are fairly rare and usually make up a small portion of a settlement agreement.

For example, any interest you accumulate on your settlement is considered taxable income. This could include interest that accumulates under state law after obtaining a judgment, or the interest that is sometimes set on delayed lost wages compensation.

Additionally, certain kinds of compensation for emotional distress are taxable. The important distinction is that this only applies to emotional distress damages that do not result from physical injuries. For example, emotional distress based on some form of contractual claim could be taxable under the law.

Medical expenses are never taxable. However, it is important that you take care not to take advantage of your compensation twice. For example, you have the right to deduct any out-of-pocket medical expenses related to your accident from your income taxes if your case has not yet settled. If you ultimately are reimbursed for those medical costs, then the amount you previously deducted must be reported as income.

Finally, punitive damages are always taxable. Unlike most forms of monetary awards, punitive damages are not intended to help make you whole. Instead, they exist to punish a defendant for extreme behavior. This is rarely an issue, as punitive damages are not generally available in personal injury lawsuits.

Learn About Tax Liability from a Personal Injury Lawyer

It is crucial that you take into account the potential tax consequences of a settlement before agreeing to anything. If a settlement ultimately results in a steep tax bill, it might not be as fair as it first seemed.

Your attorney can carefully review your case and advise you on what to expect from a tax perspective. By carefully negotiating a claim for compensation, you could limit the amount of damages that could be taxable under state or federal law.

Never settle a personal injury claim on your own. For experience you can rely on, call the Jackman Personal Injury as soon as possible to schedule your free initial consultation.

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