Many individuals decide to settle with insurance companies after experiencing injuries caused by an accident. Accepting a settlement can offer you financial compensation for your medical expenses, lost wages, pain, and suffering.
However, when accepting these offers, many people wonder: are personal injury settlements taxable? The short answer is: sometimes. The Internal Revenue Service (IRS) taxes some personal injury settlements but considers some non-taxable.
Our team at the Morelli Law Firm can review the taxes you’ll face after settling your personal injury claim. Learn more by calling or filling out our online contact form.
Do You Have to Pay Taxes on a Personal Injury Settlement?
Does the IRS tax personal injury settlements? The IRS determines how to tax a personal injury settlement based on the funds the settlement replaces. Therefore, the IRS taxes some claims – or even portions of claims – and leaves others untaxed.
The IRS does not tax personal injury settlements designed to compensate you for:
- Physical injury or sickness
- Emotional distress tied to physical illness or injury
- Lost income caused by physical illness or injury
However, you can expect to pay taxes on settlements for punitive damages, interest on your personal injury settlement, and emotional distress from causes other than physical injury or sickness.
Additionally, the complicated nature of the tax code means these rules have exceptions that can impact your tax burden. Therefore, we recommend speaking with a personal injury lawyer about the specific taxes for your settlement.
Are Personal Injury Settlements Reported to the IRS?
Regardless of whether the IRS considers your personal injury settlement taxable or not, you must report the funds to the agency. The IRS requires you to report most income and considers court awards and damages as income.
Generally, you must report all taxable income. Sometimes, you have to report nontaxable income, as well. The regulations regarding what you have to report can change yearly, so it’s a good idea to speak with a tax professional before filing your taxes.
Remember, simply reporting the settlement does not necessarily mean you have to pay taxes on the funds. The IRS only taxes some income, regardless of what you report.
Does the IRS Tax Funds from a Personal Injury Lawsuit?
Section 104 of the codes used by the IRS provides more detailed information on non-taxable personal injury settlements. For example, according to the agency, you do not have to pay taxes on some portions of your compensation if you file a lawsuit instead of settling out of court.
Generally, the same regulations on taxable and non-taxable compensation apply to court verdicts and settlements. Therefore, you may not have to pay taxes on compensation awarded for your:
- Emergency medical care or ride in an ambulance
- Time in the hospital
- Medical tests, assessments, and procedures
- Physical therapy and rehabilitation
- Medications
A personal injury lawyer or tax professional can provide you with more information about your specific situation.
Do Deductions Impact Your Tax Payments for Personal Injury Settlements?
Some individuals deduct medical expenses while working towards resolving a personal injury settlement. If you deducted your healthcare costs and received a tax benefit from the deduction, it can impact the non-taxable status of your settlement.
In these situations, you may have to pay taxes on the settlement, even the portions of the settlement for your medical expenses. You can work with a tax professional to discuss the best way to handle your healthcare costs on your taxes.
Are Personal Injury Settlements Taxable by Your State?
Generally, you must pay taxes on your income at both the state and federal levels. However, states generally consider personal injury settlements to cover medical costs, lost wages, and pain and suffering non-taxable.
However, each state makes its own rules regarding these financial awards. Therefore, we recommend you speak with your lawyer or the individual completing your taxes to ensure you understand the laws for your state.
Can You Allocate Damages for a Personal Injury Settlement?
In some cases, personal injury claims only cover one type of damage, making it easy to determine whether they are taxable or not. However, in other instances, you may receive compensation for multiple losses, including taxable and non-taxable damages.
In these situations, your lawyer may focus on allocating your compensation. Your attorney may draw up a document that states how each portion of your settlement should be used.
The IRS does not have to treat such a document as binding. However, these documents can help you limit your tax liability. Find out more about the allocation process with a personal injury lawyer.
When Can You Receive a Personal Injury Settlement?
You may receive compensation through a personal injury settlement anytime you sustain injuries or losses due to someone else’s negligent actions. For example, you may receive damages after a:
- Motor vehicle collision
- On-the-job accident
- Case involving medical malpractice
- Accident caused by a defective product
- Slip and fall accident
- Dog bite or animal attack
In order to receive compensation, a lawyer must show that another party caused your accident and injuries. Then, lawyers investigate these cases, gather evidence, and negotiate with insurance agents.
In many cases, lawyers help you settle out of court with the insurance company and can answer your questions about tax liability for the funds you receive. You may also file a lawsuit in some situations.
Contact Us to Learn More About Taxable Personal Injury Settlements
Are personal injury settlements taxable? In some cases, yes, the IRS will tax funds you receive through a personal injury settlement. However, the agency usually doesn’t tax funds designed to pay for your medical care, lost wages, or pain and suffering.
Our team at the Morelli Law Firm can provide more in-depth information about this subject when you call or fill out our online contact form.