If you’re considering pursuing a personal injury lawsuit or have recently received an injury settlement, you probably have a lot of questions about what it will mean for your finances. One question that our personal injury lawyers get asked especially often is whether or not injury settlements are taxable.
As any good injury law firm will tell you, every injury case is different, so it’s not always possible to provide concrete answers without knowing the details of the situation. However, there are a few things to consider when trying to determine whether you’ll owe taxes on a settlement or not. This guide will walk you through the basics.
Types of Personal Injury Damages
Personal injury settlements can cover anything from compensatory damages like medical bills and lost wages to punitive damages that are intended to punish the defendant. Compensatory and punitive damages are treated differently when it comes to taxes.
Punitive damages are very rarely awarded in injury settlements, so we’ll cover how they’re handled in the “exceptions” section below. For now, let’s focus on the compensatory damages that make up the bulk of most personal injury cases. The following are some of the most common damages our injury law firm sees in these types of cases, although yours might include different ones.
The most basic element of a personal injury case is a physical injury or illness caused by someone else’s neglect or willful misconduct. Whether you have a traumatic brain injury caused by a slip and fall accident or a herniated disc from a car wreck, you might be awarded compensation for things like:
- Hospital stays
- Doctors’ visits
- Physical therapy
- Labs and x-rays
In short, you might be able to get compensated for any expense that’s directly related to diagnosing or treating the physical injury or illness.
This compensation is generally not taxable unless you took an itemized deduction for these costs on your previous tax return. If you received a tax benefit for some or all of the related medical expenses, you may need to pay taxes on that portion of the settlement.
Emotional damages are awarded for emotional distress caused by another’s misconduct or neglect. Emotional distress might include:
The taxable nature of these damages rests on how they are caused. Emotional damages received in settlements as a result of discrimination or involuntary termination, for example, are usually taxable. However, if the distress is caused by a physical injury or illness, emotional damages are generally not taxable.
It’s not uncommon for an injury settlement to include lost wages. In many settlements, lost wages are counted as income, and therefore taxable.
Lost wages resulting from a physical injury or illness, however, are usually considered compensatory damages and are therefore not taxable.
Most Personal Injury Settlements Are Not Taxable
It’s important to speak with an experienced personal injury lawyer about the details of your particular case and to a tax expert about your previous deductions. But in general, it’s safe to say that under IRS Code 26 section 104, most personal injury settlements aren’t taxable and don’t count towards your income.
However, if you took tax deductions for medical expenses on previous tax returns and then received a settlement covering those expenses, you’ll have to pay taxes on the portion of the expenses you received tax benefits for. If part of the settlement is for medical expenses you paid in more than one year, you must allocate the part of the proceeds for medical expenses, on a pro-rata basis, to each of the years you paid medical expenses. See Recoveries in Publication 525 for details on how to calculate the amount.
As long as you did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, you will most likely not have to pay tax on the settlement.
When Personal Injury Settlements Are Taxable
Most personal injury settlements don’t count as income, so they’re tax-free. However, there are a few common exceptions that might mean you have to pay tax on your settlement:
- Punitive damages: if your settlement includes punitive damages, you will have to pay tax on this portion of the settlement
- Interest: if your settlement accrues interest, the interest is considered income and it will be taxed
Additionally, if you deducted medical expenses related to the injury or illness in prior tax returns and the deductions resulted in tax benefits, you’ll be responsible for paying taxes on the amount you claimed in previous years.
Learn More From Our Personal Injury Lawyers
In a perfect world, you’d be able to focus on nothing but recovery after a traumatic injury. Unfortunately, if you’re injured and it was someone else’s fault, it’s also necessary to focus on seeking compensation so you’re not left holding the bill.
Every injury case is different, and it can be a challenge to figure out how to proceed. If you’re having trouble navigating the world of personal injury settlements, our experienced personal injury lawyers can help. Contact us today to set up a free consultation.
Author information: Blaine Barrilleaux is a personal injury attorney with over 21 years of professional experience handling cases for car accidents, slip and falls, dog bites, hurricane damages, and more. With offices in Lafayette and Metairie, he’s able to help countless Louisianans get fair compensation for their injuries.