If you are an injured party seeking compensation for your personal injury, you may be wondering if your eventual settlement or award will be taxed. As with many legal matters, the answer is, “It depends”. There are many factors to be considered in determining the tax status of your award. Let’s explore how a personal injury settlement is taxed.
Circumstances in Which Personal Injury Settlements are NOT Taxable
In general, if you were awarded monetary compensation for personal injuries either through a jury trial or settlement, the proceeds are NOT subject to state or federal income tax.
Awards for pain & suffering and emotional distress as a result of your injury are not taxable. Pain and suffering and emotional pain are considered compensation for the overall injury, and are, therefore, generally not taxable.
When Personal Injury Settlements ARE Taxable
Medical Expenses – If you paid for medical expenses out-of-pocket before your case was settled, and you took those expenses as a deduction, once you’ve been reimbursed, you must then pay taxes on them. If you did not take them as an expense on your tax return, medical costs are not taxable. You can only deduct an item as an expense if you do not get reimbursed for it. For a complete definition of medical expenses you can refer to IRS Publication 502 – Medical and Dental Expenses, which says, “…Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.”
Taxes on lost income – Many settlements include an amount of money for lost wages. The IRS considers the recovery of lost wages to be “ordinary income,” and it will, therefore, consider the amount recovered to be subject to taxes. As the IRS will likely find out about your settlement, and you want to be honest about it when filing your taxes anyway, you should set aside a portion of your settlement for tax liability, so that you can pay that amount when taxes are due.
What About Punitive Damages?
Punitive damages are paid by the defendant to the plaintiff as a punishment for the offense. They are awarded in the hopes that this punishment will deter others from similar reckless or egregious behavior. Punitive damages are taxable. Accordingly, this amount must be reported on your 1040 Form.
If you have questions about your personal injury settlement and taxes, please contact Scott Bonebrake for assistance. Scott is a general practitioner in Media, PA, and has been a licensed attorney for over 25 years. Please feel free to contact Scott at 610-892-7700, or firstname.lastname@example.org.