Is a personal injury settlement taxable? This is a common question that arises when considering the financial implications of such settlements. Fortunately, personal injury settlements fall under a category of lawsuits that are exempt from taxation. Unlike most other types of settlements, the IRS does not tax personal injury settlements.
How Much Does the IRS Tax a Settlement?
- Damages resulting from mental distress or emotional distress are not taxed if they are linked to physical illness or injury.
- Loss of wages, even if they are connected with a personal injury case, must be claimed as an income.
- Punitive damages are usually taxable if they are linked to an injury settlement.
Taxable Punitive Damages
Compensatory damages include money awarded to compensate victims for their injuries, medical expenses, and other costs. The IRS distinguishes between punitive and compensatory damages when it comes to tax relief, drawing a clear line between the two.
According to the IRS, an injured victim is considered to have suffered a loss that equals their compensated gain. Therefore, there is no net gain and no taxable income.
Punitive damages can be awarded in cases where reckless, willful, or wanton behavior leads to injury or death. Punitive damages punish wrongdoing and are not meant to compensate for the victim’s losses. These damages are rare but may be added to compensatory money.
In general, punitive damages are taxed, but compensatory damages are not. However, the IRS cautions that this is not an absolute rule. The American Bar Association explains that the claim’s origin is important.
Types of Non-taxable Settlements
Many types of personal injury cases are generally not taxed. These cases are listed below.
- Dog attacks and bites
- Motor vehicle accidents concerning bodily injury and not property damage
- Medical malpractice lawsuits based on physical illness
- Premises liability cases where injuries result from neglect of property or buildings (An example would be a slippery walkway that leads to a slip-and-fall injury).
- Construction injuries and workplace accidents
- Product liability, like a car with dangerous flaws
- Faulty medications such as drugs with serious side effects
- Cases of wrongful death
Wrongful Death Claims
Wrongful death suits are personal injury lawsuits that are filed by family members in the event of wrongful death, negligence, or defect.
The court can compensate the family for financial loss, pain, and suffering that the victim experienced before their death, funeral, and medical expenses, as well as loss of future inheritance.
Other Non-taxable Settlements
The majority of worker’s comp awards (also known as workman’s comp) are not taxed at the state or federal level. This tax break also includes an award of worker’s comp given to the survivors after an employee dies.
The following are some exceptions to the rule:
- In cases where the recipient previously deducted medical costs from an occupational illness or injury.
- Even if the injury caused you to retire, you can still receive retirement benefits.
- Interest in the award of compensation for a workman’s injury.
- If you receive Social Security disability income or Supplemental Security Income: A settlement could result in a reduction of disability benefits if your financial situation is below a certain threshold.
- A skilled personal injury attorney will often structure a settlement in a way that minimizes any tax impact.
Social Security Disability
Sometimes, individuals may seek the help of an attorney to obtain Social Security Disability Insurance (SSDI). This income is taxable, but the IRS will not collect tax from recipients who don’t earn enough. It’s only when the spouse’s income or household income puts them in a higher tax bracket that they are exempt from this rule.
SSDI can be awarded as a lump sum in some cases to reflect payments. The IRS does not penalize SSDI beneficiaries for paying taxes. Instead, they allow an equitable payment plan.
The IRS calculates the amount of taxes owed in a typical household year by adding benefits for disabled persons and other household income. For unmarried individuals, the total income must be below a threshold of $25,000 to avoid paying taxes. Married couples who file joint returns have a threshold of $32,000.
In addition to federal tax, 13 states also tax SSDI.
Compensation for Lost Wages
A settlement may include compensation for lost wages. When it comes to employment lawsuits, compensation for wages lost could be at stake. According to the IRS publication “Settlements – Taxability,” this type of award is generally taxable.
Criminal Justice Awards
The IRS can impose taxes on criminal justice cases even if there is no injury involved. For instance, a robber with a weapon who breaks into a victim’s shop but does not harm them is a prime example. However, if the victim uses a tax-exempt award to repair their shop, it will not be exempt from taxation.
Additionally, the court may award compensation to the victim for a crime, according to the California Bar Association. This includes lost wages, property damage, and medical costs.
It is important to note that restitution in criminal cases is different from damages in civil lawsuits. Victims may receive both types of awards, but restitution is usually not taxed.
Emotional Distress Cases
An accident or traumatic event, such as a home invasion, can cause mental distress with physical symptoms like stomachaches and headaches. Even though they are not visible, these symptoms are still considered physical. However, the IRS taxes any settlements awarded for damages that are not visible, such as emotional pain.
However, there is an exception when emotional distress is linked to physical illness or injury. For instance, consider a car accident that results in several broken bones and a severe anxiety disorder. In this case, the anxiety disorder is not taxed due to the physical injury.
Medical expenses resulting from emotional distress are usually exempted from taxes, including expenses for counseling sessions.
How the IRS Collects Settlement Taxes
The IRS will receive any income you report when you file your tax return. It’s always best to consult with an accountant before filing more complex returns, but in general, the rule is:
- There is no requirement to report income for those who receive a compensation award due to a physical illness or injury.
- Report any punitive damages, or other taxable awards as income in your tax return.
- Report any lost wages and interest.
In these cases, attorney fees are usually included in the settlement award. The IRS can tax the recipient for the entire value of the award, even if the attorney has received a portion of it.
Experts recommend reaching an agreement with the defendant on tax-related issues to minimize tax debts. The IRS usually does not interfere with such agreements between parties in a lawsuit. It may be worth trying to retain more of the lawsuit proceeds. Personal injury lawyers with experience can help structure settlements in a way that reduces tax liabilities.
How Much Does the IRS Tax a Settlement?
As we have noted, a part of the settlement is taxed as regular income. The amount of tax due will depend on the value of the settlement.
For instance, if a taxable settlement is added to a regular salary, and the combined amount falls within a tax bracket exceeding $82,500, the individual may have to pay a 24 percent tax on their income. This was the tax rate for 2018.
Consult a California Personal Injury Attorney Today
Is a personal injury settlement taxable? Are you concerned about the tax implications of your settlement? An experienced attorney can help ease your worries. At Tenina Law, we have over 20 years of experience and are here to assist you at every stage. Best of all, our initial consultations are free, so don’t hesitate to get in touch with us today.
It’s important to keep in mind that some programs have income thresholds. For example, if your combined income from both Disability Benefits and Worker’s Compensation exceeds the threshold, your benefits may be reduced accordingly. Be sure to factor this in when considering your options.
If you want to ensure that your settlement is handled properly and avoid any unnecessary tax issues, contact Tenina Law today. Our team of experienced attorney is dedicated to helping you navigate the complexities of the legal system and achieving the best possible outcome for your case.
Schedule your free consultation now and get the help you need.