When you got hurt, it was one of the most difficult times of your life. But you got through it, and you got justice. Maybe you handled a small personal injury claim on your own. Maybe you had a lawyer to help maximize your compensation. Either way, you ended up with money for the damages you suffered.
Now, though, you may be wondering if the money you receive from a personal injury claim or lawsuit is subject to income tax. It’s a timely topic, as taxpayers across the nation are beginning to see tax documents like W-2s, 1098s and 1099s arrive in anticipation of tax season.
In most cases, your personal injury settlement can’t be taxed.
However, there are a lot of exceptions and exclusions that could make at least a part of your settlement or jury award taxable.
Let’s break down what the Internal Revenue Service (IRS) has to say.
Unlike the money you earn from working a job, much of the money you receive from a personal injury claim or lawsuit isn’t considered wages, salaries or tips, but instead “compensatory” – money meant to compensate the person for a loss.
Compensatory income is somewhat of a gray area.
“Generally speaking, most people view the term ‘compensatory’ to mean ‘nontaxable,’” the IRS noted, but that view isn’t 100 percent accurate – and assuming otherwise could leave you owing a lot of money.
To simplify a complicated situation, the IRS spelled out which portions of a personal injury settlement are specifically excluded from income taxation.
You can’t be taxed on money from a personal injury settlement or jury award meant to compensate you for:
That means the money you receive for economic damages like medical bills and lost income and for non-economic damages like pain and suffering is generally tax-free.
Think you’re good to go? Not quite.
There are exceptions to these general rules. Depending on what you did with your money and what decisions you made when filing your taxes in the past, you could still owe the IRS.
If you already got any kind of tax benefit in the past that relates to your case, you can’t take advantage of additional benefits.
For example, perhaps you deducted the out-of-pocket cost of your medical care that stemmed from the accident on a previous year’s income tax return. That’s fine and perfectly legal to do.
Now that you’ve been compensated for those expenses, you have to pay the IRS back what you deducted in the past. Failure to pay taxes on this money is known as double dipping. On your taxes, this amount is known as “other income” and belongs on your tax form.
If you earn interest on any money recovered from your personal injury case, that interest isn’t tax exempt. This includes any interest your money earns sitting in a bank account as well as any investments you buy with your settlement money. On your tax return, this is known as “interest income.”
Punitive damages from a personal injury claim are relatively rare, but if you received one, they can be taxed differently. When you receive punitive damages, the money is not intended to compensate you for your loss, but instead punish the at-fault party for their negligence.
These settlements are not considered compensatory. In many claims, including personal injury lawsuits, any punitive damages you receive are taxed as income.
Failing to include this compensation on your income tax return can be a big mistake. Include any punitive damages portion of your settlement on your 1040 form as “other income.”
Don’t make the mistake of waiting until tax season to check on this. If you received a lot of money in punitive damages, your tax burden could be high enough that you’ll need to make estimated tax payments throughout the year, the IRS reported. Fail to do that, and you could face a penalty.
Even once you’re sure about how taxes will affect your personal injury settlement, be aware of any other ways you could owe. Make sure any liens against you – like debts to your health insurance company or any funding liens – have been paid.
If you had a lawyer, he or she should have taken care of this for you similar to how we help our clients. If your personal injury attorney doesn’t do this for you, you’re on your own unless you hire someone, like a tax accountant, to help.
Remember that not knowing there was a lien doesn’t exempt you from paying it, so it’s in your best interest to find out if you owe anything to anyone sooner rather than later.
If your claim was complicated, with both compensatory and punitive damages, it can be difficult for you to determine what portion of your settlement is subject to tax. Talk to your lawyer and an accountant for help, if necessary. This is one situation where you definitely don’t want to make any mistakes!
How your claim is handled is important. The last thing you want to do is get your settlement and then realize you forgot to account for any taxes. When you work with an experienced lawyer, like Console & Associates P.C., we’ll put your mind at ease. We’ll work with your insurance company, treatment facilities, and doctors to make sure everything gets handled.
If you’re injured in an accident, you shouldn’t have to worry about taxes and at Console & Associates P.C. we make sure you don’t. We handle your claim so that you can focus on what’s most important, your health.
If you’re thinking about filing a personal injury claim, call today for your free consultation. We don’t get paid unless you win. Period (856) 778-5500.