If you’ve been hurt by someone else’s negligence or misconduct, you have the right to compensation for your damages, which may be substantial. It can be a huge relief to receive a personal injury settlement award, but how much money will you actually get to keep? Is a settlement considered taxable income?
A personal injury settlement can provide an important lifeline for your family. The last thing you need is an unexpected tax bill. The good news is that most of the proceeds recovered in personal injury lawsuits are not taxable, but some portions are considered taxable income. A knowledgeable personal injury lawyer can answer your questions, guide you through the claims process, and help you avoid any surprises at tax time.
Do I Have To Pay Taxes on My Personal Injury Settlement?
Depending on the circumstances, portions of your personal injury settlement may be considered income and taxable.
Under the Internal Revenue Code, taxable gross income includes all income regardless of the source unless the law provides a specified exemption. Fortunately, multiple exemptions apply to personal injury settlements. The most relevant exemption is 26 U.S. Code § 104, which provides that gross income does not include compensatory damages received for “personal physical injuries.” However, other portions of your settlement may be taxable.
What Parts of a Personal Injury Settlement Are Non-Taxable?
If you receive a personal injury settlement in Massachusetts, you may be wondering whether the settlement is taxable. After all, the last thing you need is another major bill when tax season arrives. The good news is that many portions of your settlement won’t be subject to federal or state taxes.
Medical Deductions
The Internal Revenue Service does not require you to report compensation for medical bills on your tax return unless you previously took a medical expenses deduction for costs associated with your injury.
For example, if you had to pay certain medical expenses out-of-pocket while waiting for your claim to be settled, you can take a deduction for those costs on your tax return. If you did take this deduction, you must report the portion of compensation you received for those expenses on your taxes as “Other Income” on line 21 of Form 1040, Schedule 1, per the IRS.
If you did not take this deduction, you do not have to report your settlement on your taxes.
Pain and Suffering
Personal injury accident victims often receive pain and suffering damages, which can be a significant part of a settlement. Because these are related to a physical injury, they are not subject to taxes.
Emotional Distress
If you suffered emotional distress or mental anguish due to your accident, you may have received these damages as part of your settlement. If the emotional distress was directly related to a physical injury, it isn’t taxable. If there is no physical component, it will be taxed.
Wrongful Death Claims
Wrongful death claims follow several different rules when compared to personal injury claims, and the same goes for taxes. For the most part, most damages in wrongful death claims are not taxable, such as medical expenses accrued before the deceased’s death. However, if the deceased’s estate is awarded punitive damages, lost wages, or interest, those damages must be reported.
Lost Wages
Any portion of your settlement that covers lost wages stemming from a physical injury is not taxable. In addition, any compensation received for lost earning capacity related to a physical injury is not taxable.
Property Loss
You might receive money for property damage as part of your personal injury settlement. For example, if you were in a car accident, your award could include damages to cover the costs of repairing or replacing your vehicle. In most cases, property loss damages are not taxable. The only exception would be if the compensation you receive exceeds the estimated value of your property. Then, the excess amount is taxable.
What Parts Of a Personal Injury Settlement Are Taxable?
Depending on what damages your settlement covers, you may have to pay taxes on some of them.
- Punitive Damages – If you were injured by egregious misconduct or intentional harm, you may receive a punitive damages award. They are considered taxable. You must report these damages as “other income” on your tax return.
- Lost Wages Unrelated to a Physical Injury – You will not pay taxes on any lost wages compensation if it is related to a physical injury. All other damages paid for lost wages are considered income, so you would need to pay income, Social Security, and Medicare taxes on the amount.
- Emotional distress or Mental Anguish – The IRS considers damages for emotional distress or mental anguish taxable if they are unrelated to a physical injury. The amount you must include as your income can be reduced by any medical expenses you had to pay for mental anguish or emotional distress not previously deducted. However, while damages received for a non-physical injury are generally includable in gross income, they are not subject to Federal employment and payroll taxes.
- Pre- or Post-Judgment Interest – Courts sometimes award interest on settlements to compensate for the time it takes to resolve a case. If you were awarded pre- or post-judgment interest, this portion of the settlement is taxable.
If you must pay taxes, you should receive a Form 1099-MISC for the taxable portion. Even if you don’t, you are still responsible for reporting the taxable portion on your tax return. The settlement tax rate you pay would be your personal income tax rate. However, this could increase if settlement proceeds put you into a higher tax bracket.
Do You Have To Pay State Taxes on Your Settlement?
Most personal injury settlement damages are non-taxable in Massachusetts because the state follows the same rules as federal laws. However, if you have received any of the taxable damages listed above, you may owe state taxes. Given the complexity of determining personal injury lawsuit settlement taxable income, we recommend consulting a qualified accountant or tax lawyer.
If you’ve been injured in an accident in the Boston area, you deserve maximum compensation for your damages. At DiBella Law Offices, we have over 20 years of experience and have recovered millions in verdicts and settlements for our clients. We focus on making the toughest time in your life easier and will fight for the full compensation you’re owed.
Call us today at (617) 870-0907 or contact us online to schedule a free consultation.