Most personal injury lawsuits in the U.S. settle out of court. A common question many accident victims ask is whether or not they have to pay income tax on personal injury settlements. It’s understandable since the Internal Revenue Service (IRS) seems to collect taxes on everything.
Chances are good you will not have to part with any of your case earnings. Generally, the proceeds from your injury case are not taxable. Learn more about the different types of settlements and if yours is taxable.
Do You Have to Report a Personal Injury Settlement on Taxes?
The IRS is notorious for taxing any source of income. Gambling winnings are taxable. If you rob a bank, the IRS expects you to include that on your tax return. So, what about your personal injury settlement?
Typically, you do not have to report money from a personal injury case on your income taxes. However, depending on what type of damages you were awarded for your case, you may have to pay taxes.
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Injuries or Sickness
There is a tax exclusion for the amount of any damages received for personal physical injuries or sickness. If you are awarded a settlement for injuries or illness and did not take an itemized tax deduction for medical costs related to that injury or sickness, your settlement is not taxable. You do not have to include your injury case settlement as part of your income on tax documents.
However, there are other instances where you could pay taxes. For example:
- If you have deducted medical expenses in any previous years for the tax benefit using Form 1040, part of your settlement may be taxed.
- If a portion of your settlement is for medical expenses you deducted from your taxable income, that portion of your settlement should be included in your taxable income.
- If you took a tax deduction for more than one year, pay taxes on this portion of your settlement on a pro rata basis.
Pain and Suffering
If you suffered mental anguish or emotional distress as a result of the accident that injured you, you may have been awarded damages for pain and suffering. The money you obtain from pain and suffering damages may be taxable income. These damages are treated similarly to compensation for injuries or sickness.
Mental anguish is not considered an injury or illness under Section 104(a)(2). If your pain and suffering did not arise from a personal injury or personal physical injury or physical illness, your settlement is taxable. The amount you have to report on your income taxes can be reduced by:
- Related medical expenses you paid for but did not deduct from taxes
- Medical expenses you deducted for mental anguish if you did not get a tax benefit
If you report any amount of your compensation for pain and suffering on your taxes, attach a statement to your tax return. Your statement should include your entire settlement amount minus any eligible medical costs you have not deducted yet or expenses you deducted without receiving a tax benefit.
Your personal injury case settlement may include money for property damage. For example, if you were in a car accident, your settlement may include funds to have your car repaired or replaced. In general, property loss damages are not taxed.
There is an exception to take note of. If your compensation for property loss exceeds your estimated loss of value, the excess amount counts as taxable income.
In the event that you are injured in an accident involving intentional harm, gross negligence, or a wanton disregard for public safety, you may be awarded punitive damages. These damages are assigned by a court to punish the defendant, not to compensate you for losses caused by injury. Punitive damages are taxable. Report punitive damages as “other income” on your tax return.
Because your case settlement may be partially or wholly taxable on your tax return, it’s important to maximize your personal injury settlement before your case resolves. It can be confusing to determine whether or not your personal injury settlement is taxable, especially if you are unsure how much of your settlement falls under each category. For more information, speak with your attorney or contact the IRS.
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