If you were the victim of an injury and are pursuing compensation from the at-fault party, you may be wondering “do you have to pay taxes on a personal injury settlement? The good news is most personal injury settlements are not subjected to taxes by the IRS. However, it’s not always a black-and-white subject.
The taxability of personal injury settlement amounts is dependent on several factors. This primarily involves the type of compensation you pursue in the claim. In this post, we want to clear up any confusion you might have and help you better understand the tax implications of your personal injury settlement. Let’s discuss.
Is a Personal Injury Settlement Taxable?
The compensation from a personal injury case you receive is typically viewed as non-taxable. Money a victim receives to compensate for medical expenses and property damage is not considered part of their income – instead, it’s seen as compensation for financial losses.
However, this does not apply across the board. There are a handful of damages within a personal injury settlement that may be subject to taxes.
The state of Illinois follows the federal guidelines for the taxability of personal injury settlement amounts. In other words, if a portion of the settlement is exempt from federal taxes, it is also exempt from Illinois state taxes.
Personal Injury Damages: Non-Taxable Versus Taxable
The majority of settlements in personal injury cases are excluded from gross income on taxes. This non-taxability of personal injury settlement amounts applies to payments made to the victim via lump sum and recurring. But there are some portions of the settlement that may be taxable.
Non-Taxable Personal Injury Damages
Most damages – economic and non-economic – incurred in a personal injury case are non-taxable, this includes:
- Medical/hospital bills
- Doctor appointments
- Future medical treatment
- Property damage
- Pain and suffering
- Emotional anguish
- Loss of companionship
- Replacement services
This list is not exhaustive. Be sure to ask your personal injury attorney about your situation to determine the taxability of personal injury settlement amounts.
Taxable Personal Injury Damages
There are a few portions of your personal injury settlement subject to taxes. The most common is lost wages. This is because lost wages are intended to compensate you for paychecks missed due to the injury. That being said, it needs to be claimed as income.
Punitive damages also impact the taxability of personal injury settlement amounts. Unlike compensatory damages – which are awarded to reimburse victims for medical treatment, property damage, pain and suffering, etc. – punitive damages are awarded to victims for the at-fault party’s willful recklessness. For instance, perpetrators who commit assaults are usually subjected to pay punitive damages.
These damages are designed as punishment for wrongdoing, not to compensate the victim for losses they incurred. Therefore, they are subjected to the taxability of personal injury settlement amounts. Punitive damages are considered rare, but the awards can be extremely high.
Generally, punitive damages are taxed and compensatory damages are not. However, this is not an absolute rule in the eyes of the IRS, per the American Bar Association. There is a lot that depends on the nature of the claim. Talk to an experienced personal injury attorney to learn more.
Types of Non-Taxed Personal Injury Settlements
The settlements for most types of personal injury cases are non-taxable, including:
- Car accidents
- Trucking accidents
- Motorcycle accidents
- Bicycle accidents
- Medical malpractice
- Defective medications
- Product liability
- Dog bites
- Slip and fall accidents
- Pedestrian accidents
- Civil rights violations
- Wrongful death
There are a few instances in which the taxability of personal injury settlement amounts applies. For example, portions of settlements from wrongful death suits are commonly subjected to taxes. These might involve a reckless act, neglect, or defect that resulted in death.
Let’s say the staff of a nursing home did not provide adequate care for the patient – leading to their death. The court may compensate the family of the victim for financial support, medical expenses, funeral costs, and so on. However, the family also seeks punitive damages due to the nursing home’s neglect of care. These damages would be the taxable portion of the settlement.
Workers’ compensation is another type of personal injury settlement that may be taxable. Most awards are not taxable at the state or federal level. However, there are some exceptions, including:
- Interest paid on the award
- The recipient had previously deducted medical expenses from a work injury or sickness
- Retirement benefits, even if the recipient had to retire due to the injury or sickness
- Recipients who receive disability or any other supplemental income – worker’s compensation settlement may impact these benefits.
The taxability of personal injury settlement amounts can get complicated. When you hire a personal injury attorney, they will walk you through all the IRS regulations.
Types of Taxable Personal Injury Settlements
Several types of personal injury settlements are subjected to taxability, including:
Social Security Disability
A victim of a personal injury may seek disability benefits, which are taxable. However, most recipients do not make enough money to owe the IRS. The exception to this rule is when the recipient’s spouse’s salary places them in a tax bracket.
The IRS determines taxes owed by taking one-half of the disability benefits and adding it to the spouse’s income. To be non-taxable, the total needs to be under the $25,000 threshold for unmarried individuals. For married couples, this threshold is $32,000.
Non-Visible Damages: Emotional Distress
The IRS commonly taxes compensation for non-visible symptoms. For example, a traumatic event may result in stomachaches. Since these symptoms are not visible, the IRS may tax for compensation sought due to these injuries.
There are exceptions to this rule, however. Let’s say a car accident resulted in broken bones, which led to PTSD. Even though these injuries are not visible, damages sought for this disorder would not be taxed – as it’s on account of the broken bones.
Moreover, any medical expenses incurred from non-visible injuries are tax-exempt. For instance, counseling expenses for emotional distress would fall under the non-taxable portion of the personal injury settlement. There is quite a bit of leeway to this rule. Speak with an experienced personal injury attorney to learn more.
Criminal Justice Awards
Awards for criminal justice cases that do not involve an injury are generally taxable by the IRS. For example, if you are a business owner and a burglar causes damage to the store – but doesn’t injure anyone – the award to fix the damage would be taxed.
How Do You Pay Taxes on Injury Settlements?
We recommend consulting with your accountant when you file a complicated return after earning a personal injury settlement. The general rules are:
- Compensation from physical injuries does not need to be reported.
- Compensation for punitive damages and lost wages must be reported.
In taxable personal injury settlements, attorney fees may also be taxable. There are some agreements you can make with the defendant to reduce your tax burden. A skilled personal injury attorney will know how to structure settlements to do this properly.
The taxability of personal injury settlement amounts can get confusing based on your circumstances. The best thing you can do is get in contact with a personal injury lawyer in your area to better understand your situation – and the tax implications.
At Midwest Injury Lawyers, our Chicago personal injury attorneys offer free consultations to victims of accidents. We’ll discuss the details of your case, determine the validity of your claim, and discuss the taxability of personal injury settlement amounts you might be entitled to. Even if you don’t have a valid claim, we are happy to point you in the right direction.