Are Personal Injury Lawsuit Settlements Taxable?

The tax implications of personal injury settlements can be confusing, but Munley Law is here to help. Let our legal team at Munley Law Personal Injury Attorneys provide the clarity and expertise you need to handle your personal injury claim settlement with confidence. We will guide you throughout the process of your lawsuit as well as any tax implications. Talk to a personal injury attorney at Munley Law today for a free consultation.

Are Settlements Taxable?

Under the Unites States’ federal tax law, personal injury settlements are generally not taxable. The Internal Revenue Service (IRS) exempts these settlements from taxation to safeguard injured victims seeking compensation from additional financial stressors.

Non-Taxable Components of Personal Injury Settlements

“The amount of any damages (other than punitive damages) received…on account of personal physical injuries or physical sickness [are exempt] (IRC, Section 104).”

The federal government does not tax your settlement money because it is meant to compensate you for the losses you have suffered. This applies to both actual economic damages, like medical bills and lost wages, as well as non-economic damages, such as pain and suffering and emotional distress.  Some of these factors include:

Compensation for physical injuries or sickness

Compensation for physical injuries or sickness from a personal injury settlement is usually not taxed. The money you receive in the settlement serves as a reimbursement to cover the accident’s costs.

Medical expenses related to the injury

Personal injury settlements cover the medical expenses you incur from accident injuries. Medical costs include hospital stays, doctor visits, medical imaging (X-rays, CT scans), medications, and rehabilitation. Be sure to keep your personal injury case receipts and records of your medical care to validate your claim.

Emotional distress directly resulting from a physical injury

Money from personal injury settlements for pain and suffering is generally not taxed; your distress must be deemed  a result of your physical trauma. This portion of your settlement helps cover the psychological impact of your injury.

Exceptions: When Is a Personal Injury Settlement Taxed?

“All income is taxable from whatever source derived unless exempted by another section of the code (Internal Revenue Code (IRC), Section 61).”

While most personal injury settlements are not taxed, there are some exceptions where they can be:

• Emotional distress that is not from physical injury or illness
• Lost income
• Punitive damages
• Earned interest on settlement monies that accumulate
• Medical expenses that have already been deducted in a previous tax year

Taxable Components of Personal Injury Settlements

Understanding compensatory damages and what part of your settlement amount must be taxed on your tax return can help you manage your tax liability.

Emotional distress not related to a physical injury

Suppose you have a personal injury claim due to emotional distress from workplace harassment, defamation of character, wrongful termination, or other circumstances unrelated to a physical injury. In that case, your settlement is liable to be taxed. The scenarios here differ from emotional stress that is medically evaluated and due to bodily injury.

Lost wages

You lose your regular income when a physical injury prevents you from working promptly. The part of your settlement that compensates for this lost income is usually taxed. For job-related injuries, worker’s compensation often covers this. In wrongful death cases, if the settlement includes compensation for the future earnings the deceased would have made, that portion is also taxable.

Punitive damages

Punitive damages are taxed because they offer payment as a corrective measure for the liable party’s negligence. The punitive portion of the settlement is intended to punish the liable party financially and to send a message to offenders, prompting them to take necessary precautions moving forward. Since these damages are not replacing already taxed monies, they are subject to taxation.

Interest on settlements

When creating a settlement agreement, directives of how, to whom, and when the monies will be distributed are particularized. The earned interest on the settlement amounts is taxable because of how the funds are held while your class is being resolved. When you finally receive a settlement, it may be paid out periodically; interest must be paid as the monies are issued. Since the money earns interest while being held, the interest-earning is considered taxable income.

Medical expenses previously claimed as deduction

You may also owe taxes on the portion of your settlement related to medical expenses, but only if you previously claimed those medical costs as a deduction on your tax return.

What Is the “Origin of the Claim” Rule?

The “origin of claim rule” considers the nature of the settlement payment to determine how it is taxed and whether it aligns with tax rules. Figuring out why you got the money will indicate if the IRS is entitled to some of it, too:

• Are you seeking funds because of your injury? These are not usually taxed.
• You missed work because of your injury; do you want money to supplement your missing paycheck? Money intended to be treated as income/pay is taxed.
• Do you have medical documentation that your emotional distress is due to your physical injury? Money due to your physical injury is not taxed.
• Are punitive damages taxable? These are always taxable.

Reporting Settlement Income to the IRS

• Use the IRS 1040 forms to report the taxable portion of your settlement. You may receive an IRS 1099 for your settlement; keep it for your records.
• Document all of your settlement expenses.
• Consult a tax professional to review your income tax filing for both federal and state if applicable.
• Consult with a personal injury attorney for a free case evaluation.

Contact Munley Law Personal Injury Attorneys for a Free Case Evaluation

The tax rules for personal injury settlements can be confusing, and mistakes might cost you more in taxes. An experienced personal injury attorney can help minimize your tax obligations for your successful settlement and ensure all tax situations are handled correctly. Munley Law, with decades of expertise, can assist you in understanding the tax implications of personal injury settlements. Contact us for a free consultation today.