According to the Internal Revenue System (IRS), personal injury lawsuits, wrongful death claims, and other claims are not considered taxable income.
The objective of settlement funds is to provide compensation for financial losses suffered in some sort of injury. Thus, the funds do not “increase” the material wealth of the taxpayer, but only restore them to the position they enjoyed previously.
Do you pay taxes on personal injury settlements?
The short answer is “no,” there are no taxes on a personal injury settlement. However, it depends on the situation. In most cases, personal injury settlements and awards are not taxable at the federal and state level.
The federal government (IRS) or the state could tax settlements or verdicts in most personal injury lawsuits, but has not done so. According to federal tax rules, the damages received for personal physical injury or physical sickness are excluded from the taxpayer’s gross income.
A Philadelphia Injury Lawyer can give information about personal injury settlement taxes and laws.
Understanding IRS and personal injury settlements
Personal injury settlements aim to provide compensation to victims for damages caused due to someone else’s reckless behavior. The IRS has strict guidelines for reporting and possibly paying injury settlement taxes. Let’s examine each of them.
Compensation for medical expenses
Compensation for medical bills may include emergency care, long-term care, hospital bills, medical equipment, and physical or rehabilitation therapies. However, you need to be aware of the IRS rule regarding the above stated fact.
If the taxpayer has received a settlement for medical bills AND has NOT claimed those medical bills as an itemized deduction, THEN the settlement for those medical bills is excluded from the taxable income. IF, ON THE OTHER HAND, the taxpayer DID claim the medical bills as an itemized deduction THEN some portion of the medical bill settlement must be included as taxable income based upon the IRS guidelines.
Property loss reimbursement
Receiving compensation for damaged property does not count as taxable income. If your vehicle is damaged in a severe auto accident, a settlement for the value of the vehicle is not considered income.
Lost wage compensation in personal injury cases
If an injury victim receives compensation for lost income due to injuries, that compensation will not count as taxable income. In most situations, victims receive a lump-sum payment that comprises medical expenses, lost wages, and pain and suffering after an car accident.
Compensation for pain and suffering after an injury
Many personal injury settlements comprise non-economic damages such as emotional distress or pain and suffering. The IRS rules state that there is no difference between medical compensation and settlement for pain and suffering. Therefore, the victim may not have to pay taxes on settlements for general damages.
Worker’s compensation claims
Funds relating to worker’s compensation do not usually count as taxable income unless they are engaged in outrageous behavior like drunkenness. Under worker’s compensation coverage, you may receive direct benefits or payment for medical bills.
In other cases, you may also receive a lump sum amount or periodic payment owing to long-term injuries or disability. In these types of personal injury cases, the funds received do not count as taxable income.
When do you have to claim a settlement as income?
In most personal injury cases, you do not have to claim the funds that you receive as part of your settlement as income. In cases of emotional distress, such as suffering from PTSD, depression, or anxiety, you could file a claim for emotional distress after an accident.
Settlements for emotional or mental distress are generally non-taxable, however, you should consult an experienced attorney for advice on the details.
Punitive damages may be awarded when there is gross negligence. Some examples may include a defective product or the wrongful death of a person.
Punitive damages do not fall under the personal injury income exemption. The IRS considers punitive damages as taxable income and you must claim them accordingly.
A liable party’s insurance company may take months or years to pay compensation. The claim will collect interest during the delay, which can also be awarded as part of a settlement. This will also be considered taxable income.
How to Avoid Paying Taxes on a Lawsuit Settlement
When you receive a settlement, you should consult an experienced legal professional before taking the money to fully understand the tax implications. You may be moved into a higher tax bracket. To avoid this, you can spread the settlement payment over several years, to reduce the income tax, or preclude moving into a higher bracket.
In preparing the tax forms you must also correctly categorize your settlement as some parts may be taxable and some may be non-taxable. Correctly allocating the award as income or non-taxable money can save you money in taxes.
You need to have an understanding of your potential tax liability. Effective handling of your taxes and expenses after a settlement may also help reduce your taxes.
If you have questions about personal injury claims and settlements, our injury lawyers will be happy to assist you. Start a free initial consultation today or give us a call.