After an injury that wasn’t your fault, receiving compensation for your medical expenses, lost income, and other losses can be an important part of your recovery. A serious injury can result in significant medical bills and may prevent you from working for weeks, months, or even longer.
If you receive a personal injury settlement or jury award, you may also have questions about what happens when you file your taxes. Is the settlement taxable? Will you receive a Form 1099? Do you have to report the money to the IRS?
The answer depends largely on what the payment was intended to compensate you for.
At Fleschner, Stark, Tanoos & Newlin, we help injured people pursue compensation for the losses caused by accidents and other negligent acts. Understanding the potential tax consequences of a settlement is another important consideration when evaluating a resolution of a personal injury claim.
Generally, compensatory damages received because of a personal physical injury or physical sickness are not included in federal taxable income under Section 104(a)(2) of the Internal Revenue Code. This can include compensation for medical expenses, pain and suffering, and other damages that arise from the physical injury.
The IRS applies this rule to damages received through either a settlement or a judgment. In other words, receiving compensation through a negotiated settlement doesn’t automatically make the money taxable simply because the case was resolved outside of court.
However, there are important exceptions and circumstances that can affect the tax treatment of money you receive.
The tax treatment of a settlement depends in part on whether the damages were received on account of personal physical injuries or physical sickness.
Examples can include compensation arising from:
The underlying facts and the language of the settlement agreement can matter when determining the tax treatment of the payment.
Many injured people assume that any money designated as lost wages must automatically be taxed as ordinary income.
That’s not necessarily the case in a personal injury claim.
The IRS states that compensatory damages, including amounts that replace lost wages, may be excluded from gross income when they are received on account of a personal physical injury or physical sickness.
This is different from lost wages received in many employment-related claims, which are generally taxable.
Because the tax treatment depends on the underlying claim and what the payment represents, it’s important to look at the specific circumstances of the settlement.
This is another area where the answer depends on the circumstances.
Under IRS guidance, damages for emotional distress that are attributable to a personal physical injury or physical sickness are generally treated the same way as damages for the underlying physical injury.
However, emotional-distress damages that do not originate from a physical injury or physical sickness are generally taxable, subject to certain exceptions for qualifying medical expenses.
For example, a personal injury claim involving a physical injury may include compensation for the emotional consequences of that injury. That treatment can be different from a claim based solely on emotional distress without a physical injury.
Generally, yes.
The IRS states that punitive damages are taxable even when they arise from a case involving a physical injury or physical sickness.
There is a limited exception involving certain wrongful-death cases, so the specific circumstances of the case matter.
Interest is generally taxable.
The IRS identifies interest received on an award as taxable income.
This means that even when the underlying compensatory damages for a physical injury are not taxable, interest included in a settlement or judgment may be treated differently for tax purposes.
There is another important exception to the general rule.
If you previously deducted medical expenses related to your injury on a tax return and received a tax benefit from that deduction, the portion of a later settlement attributable to those expenses may be taxable.
This is one reason it’s important to discuss a significant settlement with a qualified tax professional before determining how it should be reported.
A personal injury settlement can include compensation for several different types of damages. The IRS explains that settlement payments can be allocated among different elements, and the tax treatment can depend on what the payment was intended to replace.
Attorney Caleb Fleschner explains why these details shouldn’t be overlooked when resolving a personal injury claim:
“When we’re negotiating a personal injury settlement, our focus is on making sure the agreement accurately reflects what our client is being compensated for. The tax consequences can be different depending on the type of damages involved, so clients should understand how the different components of a settlement may be treated before they finalize an agreement.”
A settlement agreement should accurately describe the claims and damages being resolved. However, the tax treatment ultimately depends on federal tax law and the facts of the individual case, not simply on what a settlement agreement calls a particular payment.
For many people who receive compensatory damages because of a personal physical injury or physical sickness, the answer is generally no at the federal level. But there are important exceptions, including certain punitive damages, interest, and amounts attributable to medical expenses that previously generated a tax benefit. State tax treatment can also vary, so you should not assume that the federal treatment automatically answers every state-tax question.
If you receive a substantial settlement, consider consulting a qualified tax professional about your individual circumstances.
After an accident, your primary concern should be your health and recovery—not trying to navigate complicated legal and financial questions by yourself.
At Fleschner, Stark, Tanoos & Newlin, our Indiana personal injury attorneys help injured people understand their legal options and pursue compensation for the losses caused by someone else’s negligence.
If you’ve been injured in an accident and are considering a personal injury claim, contact us today for a free consultation.
Disclaimer: This article provides general information about the potential federal tax treatment of personal injury settlements and is not tax or legal advice for any particular situation. Tax laws and individual circumstances can vary. Consult a qualified tax professional regarding the tax treatment of your settlement or award.
Fleschner, Stark, Tanoos & Newlin
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The financial burden that often comes with a serious injury can be too much for many people to bear. Unexpected medical debt, damaged personal property, and the sudden loss of income can impact the budgets of most families. The good news is that a successful injury claim could help reduce that financial strain after a serious accident. Get in touch with a Terre Haute personal injury lawyer with Fleschner, Stark, Tanoos & Newlin to learn more.
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