Are Personal Injury Settlements Classified as Income?

You might have heard that the majority of personal injury cases resolve before or during trial. Once you accept an insurance company’s settlement offer and sign a release, the case is resolved. Ideally, accident victims would receive compensation quickly so they could return to living their life. Unfortunately, however, it is often the case that the government is entitled to a share of a settlement. This article reviews just a few important issues to consider about personal injury settlements as taxable income.

Types of Damage Awarded in Personal Injury Lawsuits

The most important thing to understand about what amounts are taxable in personal injury settlements is that different types of damages are recoverable in personal injury lawsuits. Some of the most common damages received by personal injury victims include:

• Medical expenses are designed to compensate accident victims for the full value of medical treatment related to an accident and the associated injuries.
• Lost wages are designed to compensate an accident victim for the payments that are forfeited as a result of not being able to work a job. This amount can also include the loss of earning capacity and future wages.
• If an accident victim incurred any damage to property during an accident, it is possible to receive compensation for its repair or replacement.
• The category of non-economic losses includes compensation for things like disability, pain, suffering, and the decreased quality of life following an accident.

Compensation for Physical Injuries is Not Taxable

The compensation received in most personal injury cases is not taxable under either existing federal or state law. This is true regardless of whether you settled a case before or after pursuing a personal injury lawsuit in court. It does not matter if you ended pursuing compensation in court and won a verdict. Neither the federal government nor the state can tax settlements or verdict proceeds in most personal injury claims. Consequently, personal injury damages that are meant to compensate a person for things like lost wages, medical bills, and pain and suffering are not taxable.

Exemptions Exist

Even if you incur a physical injury or illness, you will still be taxed on the damages that result from a breach of contract if such an issue arises in your case. Another portion of personal injury verdicts that are not taxable is interest on a judgment.

Punitive damages are taxable. Punitive damages are utilized as a form of punishment for grossly negligent behavior. These damages are awarded in personal injury cases to victims who suffered damages and can serve as economic reimbursement; they are designed to communicate a message to the responsible party that destructive or negligent practices are not tolerated.

If you have a punitive damage claim, your attorney will ask the judge or jury to separate its verdict into compensatory and punitive damages. This structure ensures that you can establish to the Internal Revenue Services that part of the verdict was for compensatory damages, which are not taxable.

Important Facts About Emotional Injuries

Settlements or verdicts are not taxable provided that they arose from physical injuries. If a person has a claim for emotional distress, for example, but no physical injury exists, then the resulting settlement would be considered taxable unless you can establish even the smallest amount of physical injury.

Make Sure That as Much of Your Settlement as Possible is Non-Taxable

Sometimes, an individual might have two claims against a deceased individual. One of these claims will relate to a personal injury and the other will not. In these situations, particularly if a personal injury claim is much larger than a non-personal injury claim, a plaintiff should explicitly state in a settlement agreement what amount relates to a settlement for a personal injury and which concerns the non-personal injury claim. While the Internal Revenue Service can challenge the taxability of a settlement, allocating a settlement in such a way affords a person the chance to have the greatest amount excluded from taxation.

Tax Reforms Have Impacted How Personal Injury Settlements are Treated

 The Tax Cuts and Jobs Act was passed in 2018 and contains some substantial modifications regarding the tax treatment of assets received as a result of a personal injury settlement or a jury award. To qualify for exclusion from federal taxes, the amount that a person receives from a settlement or jury award must be directly related to physical injuries. This means that if a person receives anything to compensate for things like emotional distress or pain and suffering, the recipient might be forced into paying taxes for that financial gain. Following the reform, regulations were enacted that require the recipient of a personal injury settlement to pay taxes on any amount received from a civil action, even if the plaintiff incurred physical injuries in the accident. The Internal Revenue Service defines these symptoms as the “normal” symptoms associated with physical injury and as a result, these are no longer considered part of bodily injuries.

Advice on Reducing Taxes Paid on Personal Injury Settlements

If you or a loved one was injured in an accident and received a financial settlement for the injuries that you now face, you will likely end up facing some degree of taxes. Fortunately, there are some helpful strategies that you can follow to reduce the amount of taxes you have to pay. Some of these tips include:

• There are two types of damages awarded as compensation — general and special. General damages include non-taxable pain and suffering, but special damages are subject to taxes. It is often possible to pay less in taxes by considering how damages are categorized.
• If a settlement leads to an increase in income, it is important to communicate with the marketplace to inform them about your change in healthcare. ‘
• If you received a large amount of compensation, it is possible to avoid taxes by disbursing funds over an extended period.

Speak with an Experienced Accident Attorney

If you or a loved one has questions or concerns about how to pursue compensation after an accident occurs, one of the best steps that you can take is to speak with an experienced attorney. Contact Cohen & Jaffe LLP today to schedule a free case evaluation.

For a free legal consultation, call 516-358-6900