Is My Personal Injury Settlement Taxable
You should file a lawsuit if you are injured in an accident caused by someone else’s negligent action. Out of this lawsuit you may end up with a substantial amount of money to cover the damages you suffered. Most people wonder whether the compensation money is taxable especially when they are doing their taxes at the beginning of the year. The answer is that in most cases personal injury settlement is not taxed, but there are a significant number of exceptions.
What The IRS Says
The personal injury settlement you receive is considered as compensatory income by the IRS. But just because it is “compensatory income” does not mean that it cannot be taxed in all situations. You cannot be taxed for personal injury settlements meant to compensate for:
- Emotional distress resulting from physical injuries
- Lost wages caused by the injuries
- Physical injuries
In other words, the money you receive for lost income, medical bills, and pain and suffering are not taxable.
What Is Taxable?
You may still owe the IRS money even if the settlement amount you got is not taxable. For example, people that deducted the out of pocket medical costs from their previous tax return may have to pay back what they deducted after they get compensated. Apart from that, you have to pay tax for interest earned on your settlement money that is sitting in a bank account. In addition, any investments that you buy using your settlement money can also be taxed.
You may also have to pay taxes if the amount you got as settlement was for emotional injury only. For example, settlements for emotional distress where there is no physical injury will be taxed. Your compensation will still be taxed even if the emotional distress caused you to suffer some physical symptoms. The only way you can avoid paying tax in this situation is if you can prove the slightest amount of injury.
Punitive Damages Are Taxed
Not many people know that punitive damages are not compensatory income. The IRS considers punitive damages as income because they are awarded to punish the at-fault party not to compensate. That means that you have to include any punitive damages as “other income” on your 1040 form. Anyone that fails to include punitive damages while filing their tax returns may face penalties.
You personal injury lawyer can ask a judge or jury to clearly separate the amount you get as punitive damages from the actual compensation amount in their judgment. This will make it easier to prove you don’t owe the IRS money if the verdict did not include any punitive damages. But getting punitive damages is extremely difficult in personal injury cases. You should also make sure that any liens against you have been paid to avoid trouble with the IRS.
Fortunately, an experienced personal injury lawyer is also well-versed in taxes on injury settlements and can help you comply with IRS rules. Such a lawyer can also work with your insurance company, doctors and treatment facilities so that you can spend your time recovering from your injuries.