Personal Injury Settlements and Taxes: What You Need to Know

Before calculating how much compensation you will be receiving, it is important to understand whether the proceeds you receive from a personal injury settlement are taxable. The personal injury lawyers at Muller Brazil can guide you through the particular aspects of your claim and advise you as to which portions of your settlement you may have to pay taxes on.

Do You Have to Pay Taxes on a Personal Injury Lawsuit?

The Following Settlement Proceeds are NOT Taxable:

Personal Physical Injuries or Physical Sickness

In general, physical damage to a person’s body (a burn or wound), and physical sickness  (transverse myelitis or a heart attack) settlement proceeds are not taxable.

Exceptions:

However, if you are awarded a settlement for personal physical injuries or physical sickness, the portion of the settlement that compensates for medical expenses deducted in any years prior, is in fact taxable. Medical expenses include charges for visits to physicians’ offices, medical procedures, hospital bills, medicine, and recuperative therapy. The IRS reasons that it is not fair to receive a tax deduction for medical expenses that were paid off by money from your settlement.

Emotional Distress or Mental Anguish

Similarly, settlement proceeds for emotional distress are likewise non-taxable if they originate from a personal injury or physical sickness. Emotional distress passes under various names, including mental suffering, mental anguish, mental or nervous shock, and the like. Emotional distress includes all highly unpleasant mental reactions.   

Exceptions:

If the settlement for emotional distress or mental anguish does not originate from a personal injury or physical sickness, then the settlement proceeds are taxable. For example, Jane’s business competitor tells several people that she is not properly sanitizing her salon. The statement is false, but Jane’s business is ruined because of the loss of her reputation. Jane then filed a defamation lawsuit against her business competitor and received a settlement.  Jane’s settlement is taxable because she suffered purely emotional and financial damage. 

Other examples of taxable proceeds include settlements received from wrongful termination, harassment, discrimination and invasion of privacy claims.

Lost Wages or Lost Profits

A settlement award with compensation for lost wages or lost profits is generally non-taxable in a personal injury case. 

Exceptions:

Lost wages or profits in other cases may be taxable.

Loss-in-Value of Property

Property settlements for loss in value of property are not taxable if the settlement is less than the adjusted basis of the property. You must, however, reduce your basis in the property by the amount of the settlement. 

Exceptions:

If the settlement amount is more than the adjusted basis of the property, the excess is taxable as a capital gain.

These Settlement Proceeds are Taxable:

Interest

Interest on any settlement is generally taxable as interest income.

Punitive Damages

Damages awarded in addition to actual damages when the defendant acts with recklessness, malice, or deceit are known as punitive damages. Punitive damages are intended to punish by way of penalizing the wrongdoer or making an example to others. Punitive damages are taxable even if the punitive damages are received in a settlement for personal physical injuries or physical sickness.

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We’re here to help.The attorneys at Muller Brazil are knowledgeable in complex legal issues including taxation on personal injury settlements. Contact our office today for a free no obligation case evaluation.