If someone harms you through their intentional wrongful act or negligence, you may file a civil lawsuit to get compensation for the losses you suffer. You can use out-of-court settlement or the court to receive payment for your damages.
Perhaps, you are wondering if personal injury settlements are taxable. Yes, the government takes a portion of the large sum you receive as tax.
This piece enlightens you on handling taxation after receiving your personal injury compensation.
Understanding Personal Injury Settlement
When an individual hurts you, the law permits you to file a claim to receive compensation for your damages. You can negotiate a settlement through a gentlemanly agreement or file a civil case in court.
An insurance firm pays a personal injury settlement on behalf of the defendant after the negotiation or court order. The payments you receive are compensation for medical expenses for treating your injuries, lost earnings for missing work or inability to work due to the injury, emotional distress, and the pain and suffering the injuries are causing you.
It is essential to answer the taxability of personal injury settlements because they can be worth thousands or even millions of dollars.
Are Personal Injury Settlements Taxable on the Federal Level?
Fortunately, the federal government does not tax personal injury settlements because the funds are to compensate you for the losses you suffered. This exemption is for both economic and non-economic damages.
However, the government will not tax emotional distress and pain and suffering only if physical injuries exist. For instance, if you develop PTSD without physical harm after a dog lunges at you, the government will tax the settlements you receive for emotional distress.
The authorities do not tax actual economic damages because the victim only recoups their lost funds. At the same time, they also exempt non-economic damages because the monies are to “make you whole” for losses you cannot receive direct compensation for, like pain and suffering.
Since they are compensatory damages, the state believes you have undergone a loss or suffering equivalent to the funds you received, and as such, it is needless to pay tax on them.
Are Personal Injury Settlements Taxable on the State Level?
Certain states also collect income taxes, distinct from what the IRS charge people when they earn money. Such taxes exist under different rules.
Despite the differences in tax rules from one state to another, states also generally exempt victims from paying taxes on personal injury compensation. States also believe that the damages are compensation for losses suffered; it is neither earning nor a windfall.
Possible Exception for Medical Bills
It is not straightforward to answer the question on the taxation of personal injury settlements because there are some circumstances where you may have to declare some of the earnings from your compensation on your federal and/or state tax return. Such could happen if the accident victim took a deduction for medical bills related to the harm in the years preceding the settlement.
Suppose the accident victim claimed a tax deduction for medical bills, and they receive damages for those bills. In that case, they are to declare earnings from the settlement intended to compensate them for the expenses they took a deduction for—if they enjoyed a tax benefit from it.
Are Punitive Damages Taxable?
Punitive damages are taxable because they punish defendants for being intentionally reckless. The damages aim to deter the defendant from becoming involved in such destructive behavior in the future. Since the money does not make you whole from your losses, the authorities may tax you.
However, the government will overlook it if the claim is for wrongful death; the government does not tax punitive damages for wrongful death. If you are confused about the tax status of your punitive damages, contact an expert tax lawyer and personal injury attorney for enlightenment and guidance.
