A personal injury settlement refers to the compensation you get for losses suffered after sustaining an injury. You can get reimbursement through negotiations with the defendant’s lawyer, or court order.
In an ideal world, after you reach an agreement, you would take your money and continue living your life. In reality, however, you have to check whether you owe the government any taxes following a personal injury settlement. This is essential to avoid tax penalties that follow a failure to remit levies to the IRS.
Here is all you need to know about whether or not your compensation is taxable.
When a Personal Injury Settlement Is Not Taxable
The general rule when it comes to taxing personal injury settlements is that compensation for physical injuries is not taxable. As clear cut as that may sound, it can be quite confusing to determine what counts as bodily injury.
Does suffering from a stomachache after eating contaminated food count as a physical injury? What about the mental anguish that follows an accident, even though you did not sustain any physical harm?
Typically, any money you receive as reimbursement for medical expenses is not taxable. The same applies to compensation for loss of employment, loss of wages, and loss of consortium that is a result of your injuries. Even payment for attorney’s fees is not taxable.
However, there are some exceptions to this rule. For instance, if you claim a tax deduction for medical expenses that you pay from your pocket pending the settlement of a personal injury claim, you will have to remit the deducted amount to the IRS once the payment arrives.
Remember, the goal of compensation is to return you to the position you would have been in had you not suffered the injury, not to benefit you in any way.
When a Personal Injury Settlement Is Taxable
In 2017, the president signed a law that provides that compensation for emotional injury is taxable. This means that if you base your claim purely on the emotional distress that you suffered from a personal injury, then the settlement you get will be taxed. This includes mental trauma, embarrassment, depression, and anxiety.
Knowing what counts as a purely emotional loss can be somewhat confusing. This is why you should have a personal injury attorney guiding you through the entire process.
The lawyer will help outline damages flowing from emotional pain so that you only pay taxes for that amount. In case you get your compensation through the court, the attorney will request the judge to outline the damages for emotional strife so that you can calculate the taxes more accurately.
Any interest on the settlement amount is automatically taxable. The same applies to punitive damages since these are more about punishing the defendant that compensating you for your loss. However, punitive damages in wrongful death suits are not taxable.
Lost wages resulting from non-physical injuries are also taxable. This applies, for instance, where you are unable to work well because of emotional trauma caused by the defendant.
Generally, if you are receiving compensation for suffering a physical injury, the state or IRS are not entitled to any taxes. Even compensation for emotional losses resulting from a bodily injury is not taxable. However, if your suit is based on psychological damage without evidence of physical harm, your settlement amount is taxable.
Any interest you get from a settlement agreement is taxable. Additionally, you will have to pay taxes for punitive damages, except where it is a wrongful death case.
It is important to consult an experienced personal injury attorney promptly if you find the laws on taxing settlement amounts to be confusing. They can help you avoid hefty tax penalties while ensuring that you get fair reimbursement for your pain.