Is the money you receive from a personal injury settlement or judgment the sort of income for which you are required to pay taxes? The answer is not quite as simple as yes or no. A personal injury lawyer can help you break down the different types of compensation in such a settlement, but only a tax advisor can give you a final answer that takes into account your particular situation, location and time, especially since tax codes are sometimes subject to change. However, it is often helpful to have a little background information so you know what questions to ask your tax advisor, so here is our guide to when and how taxes apply to a personal injury settlement.
The parts of the US tax code that are applicable to most personal injury settlements essentially describe the types of compensation that are not taxable. By and large, most of the money you will receive from a personal injury settlement or judgment is considered to be either compensatory or general damages: in other words, this is money that reimburses you for medical expenses, pain and suffering, income you may have lost due to your injuries, or some combination of the three. Even out of these categories, most settlement compensation is specifically for your injuries and any medical expenses they made necessary. This means that the settlement is not taxable, since it is directly compensating you for your losses.
Lost Income Payments
The biggest exception to this is if part of your settlement is compensation for wages or other income that you have lost due to your injuries, including time you spend seeking medical treatment and recuperating from your injuries. This kind of compensation essentially stands in place of income that you would have received, ordinary income, which would have been taxable if you had received it in the usual way instead of as part of a settlement. Therefore, you will need to report and pay taxes on that compensatory money. Your personal injury lawyer should be able to explain the breakdown of your settlement to you so you can identify which parts are taxable and which are not.
Although not common, it is possible that part of your personal injury settlement or judgment is considered to be punitive damages. This is a specific type of personal injury damages, meant to punish the defendant for some type of unusually wrong and unlawful actions and discourage the defendant from repeating the actions that led to your injury. This is unusual, but fortunately fairly straightforward in terms of taxes: punitive damages are nearly always considered taxable income.
Personal Injury Lawyers Can Help
If your settlement is made up of several types of compensation, work with your personal injury lawyer to calculate out what portion of it is considered reimbursement for medical bills, what part is lost wages compensation, and what part (if any) is punitive damages; then pay taxes just on the taxable portions. For a mixed or otherwise complicated settlement or judgment, it is often a good idea to have your tax advisor review with you to ensure that you have correctly identified what parts of the settlement are taxable.