Understanding How the Government Taxes Personal Injury Settlements
As a personal injury lawyer, one of the most common questions clients ask is, “Do I have to pay taxes on my personal injury settlement?” The answer isn’t always straightforward, as it depends on the nature of the settlement and the types of damages awarded. In this article, we’ll break down how the government taxes personal injury settlements to help you better understand what to expect.
General Rule: Personal Injury Settlements Are Not Taxable
In most cases, personal injury settlements are not taxable. The IRS generally does not tax settlements for physical injuries or physical sickness. This includes settlements for pain and suffering, emotional distress (related to physical injury), and medical expenses. Essentially, if your settlement compensates you for bodily injury, it’s typically tax-free.
However, there are exceptions. Let’s take a closer look at the different types of damages and how they may be taxed:
1. Compensation for Medical Expenses:
If your settlement includes reimbursement for medical expenses you’ve already paid out-of-pocket, this portion is generally not taxable. However, if you previously deducted these expenses on your tax return (for example, in the year they were paid), the IRS may require you to report that portion as income.
2. Compensation for Lost Wages:
If your settlement includes compensation for lost wages, that portion is taxable. This is because wages are considered taxable income, regardless of whether they’re paid through a settlement or as a regular paycheck.
3. Pain and Suffering:
Pain and suffering settlements related to physical injuries are usually not taxable. However, if the injury is psychological (not tied to a physical injury), the IRS may treat it differently and require tax payments on that portion.
4. Punitive Damages:
Punitive damages, which are awarded to punish the defendant and deter future wrongdoing, are taxable. The IRS treats punitive damages as income, so they must be reported on your tax return.
5. Emotional Distress:
If you are compensated for emotional distress, the taxability depends on the source of the distress. If the emotional distress stems from a physical injury, the settlement is generally not taxable. But if the distress is unrelated to a physical injury (e.g., a workplace discrimination claim), the portion related to emotional distress may be taxable.
6. Interest on Settlements:
Interest earned on a settlement is taxable. If you receive interest on your settlement (often in cases where the settlement takes time to finalize), it will be considered income and taxed accordingly.
Consult With a Tax Professional
Understanding the tax implications of a personal injury settlement can be complicated, and the IRS has specific rules regarding different types of damages. To ensure you’re handling your settlement properly, it’s a good idea to consult with a tax professional. A tax expert can help you navigate the nuances of your specific case and ensure you’re complying with the law.
At Johnson Attorneys Group, we’re here to help guide you through the legal process of your personal injury claim. If you have any questions about your settlement or need assistance understanding the tax consequences, please reach out to us at 1-800-208-3538.
Stay informed, stay protected, and we’ll continue to fight for the justice you deserve.
