Do I Have to Pay Taxes on My Injury Settlement?
Are Personal Injury Settlements Taxable?
If you’re expecting a personal injury settlement and are wondering about statutory deductions, the good news is they are not taxable at the federal level. Section 104 of the IRC excludes taxable income from lawsuits, awards, and settlements.
The IRS exempts the settlement award from the usual taxation since the funds received are meant to compensate you for the losses you endured due to the injury.
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Even so, the facts and circumstances of each settlement payment should be considered to determine each settlement’s purpose since some elements are not tax-exempt.
Awards and settlements are often divided into two groups to determine if the payments are taxable or non-taxable. The first group involves compensation related to physical injuries, and the second group includes claims related to non-physical injuries.
Here’s how the tax system works:
- Compensatory damages such as lost income received for physical injury are excluded from gross income, except for punitive damages.
- Damages from a non-physical injury such as emotional anguish, although usually included in gross income computation, are not subject to federal employment tax.
- Damages related to mental or emotional distress from non-physical injuries are only excluded from gross income and taxation on account of physical sickness or injury.
When Do Personal Injury Settlements Become Taxable?
Specific damages fall in the tax bracket, including punitive damages, previously deducted medical costs, punitive damages, interest on your settlement, and award for lost income.
Punitive Damages
While most elements in a personal injury settlement are tax-exempt, there is an applicable tax for punitive damages. Punitive damages are not available in all personal injury settlements; however, they are often awarded when the defendant’s actions are egregious.
A jury awards punitive damages not to compensate the injured victim but to punish defendants and deter bad behavior. The punitive damages award doesn’t reimburse your original state before the loss, so you may be taxed for the money you receive.
However, punitive damages are exempt if received after a wrongful death claim. The IRS considers the damages tax-exempt in states where state law only provides punitive damages for wrongful deaths.
Exception for Medical Expenses
It is possible to take an itemized deduction for medical bills for your injury in the years leading to the settlement.
Suppose you claim the tax deduction for your medical expenses followed by compensation for the exact costs. In that case, you must declare income from the settlement meant to compensate you for the expenses you deducted against— if the deduction provided offered you a tax benefit.
For instance, if you took a tax deduction of $25,000 for injury-related medical expenses and received a settlement with payment of those expenses, you may need to declare up to $25,000 of your settlement as taxable income.
You’ve finally settled your personal injury claim, or gotten a successful jury verdict. Now you’re likely facing a new uncertainty: will you have to pay taxes on the money you receive as
compensation?
Personal injury attorneys are acquainted with the complex regulations involving settlements and taxation and can explain how taxes will apply to your specific case. At Burger Law, we have over 30 years of experience getting great results for our clients, and we answer questions for free every day. If you have any questions about the personal injury claim process, speak to a member of our team today at or fill out our online form. With offices in St. Louis, Chicago and elsewhere, we serve the
injured throughout Missouri and Illinois.
If you were recently injured and want to know how much your claim may be worth, fill out our free personal injury calculator.
Schedule a free case evaluation here. Litigation attorney
“I’ve dedicated my entire life to helping our clients receive full compensation for their injuries.”
Gary Burger
When Do You Have to Pay Taxes on Injury Settlements?
Generally, the IRS taxes income – something that makes you wealthier than you were before. Since the purpose of most types of compensation in an injury claim is to “make you whole“, most settlements and verdicts aren’t taxed. However, there are notable exceptions based on what kind of settlement you receive and under what circumstances. Settlements and judgments are generally viewed under the same tax laws, so it doesn’t matter if you receive your money through a settlement or a trial verdict. The details on when you have to pay taxes off a settlement or verdict can be found in Internal Revenue Service Regulation 26 C.F.R 1 and Publication 4345.
Whether or not you have to pay taxes on your settlement will depend on the type of compensation you receive:
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- Medical expenses — If you did not take an itemized deduction on a previous year’s tax return, any
settlement related to expenses for an illness or injury are not taxable. Meaning, you do not have to pay taxes
on any compensation you receive for an emergency room visit, chiropractic appointments, medications, or any
other medical expense.However, if your insurance covered part or all of your medical expenses, they have a right to place a lien on
your settlement. You can read more about how personal injury lawyers reduce liens in an injury case here. - Non-economic damages — Any compensation
related to emotional distress, mental anguish, pain and suffering, inconvenience or any
other general damages are also not taxable.
- Medical expenses — If you did not take an itemized deduction on a previous year’s tax return, any
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- Lost wages — If you’re compensated for lost income, that amount will generally be subject to income
tax, since your original income would have been taxable if you hadn’t had income loss. But, it’s important to
note that you only have to pay taxes on the compensation directly related to your lost wages damages. For
example, if you recovered a $100,000 settlement, but only $5,000 of that was for lost wages, you would only have
to report the $5,000 as income. The other $95,000 is not taxable.
- Lost wages — If you’re compensated for lost income, that amount will generally be subject to income
-
- Property damage — Compensation for property damage, for example damage to your vehicle in a car accident, is generally not taxable, so long as you
don’t have any money left over once your property has been repaired or replaced. Any extra, for example if the
insurance company overpaid you or you carried out the repairs yourself, must be taxed as income.
- Property damage — Compensation for property damage, for example damage to your vehicle in a car accident, is generally not taxable, so long as you
-
- Punitive damages — Though rarely awarded,
punitive damages from a defendant who exhibited especially dangerous or egregious behavior are subject to taxes
and must be reported as “Other Income” on your Form 1040.Additionally, certain states have laws that may affect how much of your punitive damages you retain. For
example, in Missouri, under Revised Statutes
§537.675, the state may claim up to 50 percent of your punitive damages award for the state’s Tort Victims Compensation Fund.
- Punitive damages — Though rarely awarded,
In short, any compensation you received for the direct financial, physical and emotional harm you sustained because of your injuries will not be taxed. Anything “extra” or deemed to be over that amount, is taxable as income.
Strategies to Minimize Tax Liability
If you are about to receive a taxable injury settlement, the following strategies might help you avoid paying more than you need on your settlement recovery. Always discuss such options with your car accident attorney.
Request a Structured Settlement Annuity
A settlement annuity is an effective tax-saving method because it allows settlements to be split into smaller payments yearly. As a result, the personal injury settlement is taxed at a lower rate than the rate applicable to a single payout.
Here’s how a structured annuity settlement works:
- Instead of receiving the entire settlement amount at once, a portion of the funds is used to purchase a structured settlement annuity.
- The annuity provider—a highly rated insurance provider— then pays the injured victim at a set schedule.
- You can set the annuity structure to make payments for a few years, several years, or the rest of your life.
- You can customize the annuity program to make payments that meet your future goals and needs.
The strategy can save you a substantial tax amount due to the annuity by keeping you in a lower tax bracket. In addition to a tax benefit, the structured annuity settlement offers a long-term source of income with a constant return unaffected by market volatility.
Maximize Medical Expenses Exclusion
In most cases, medical expenses comprise a substantial portion of a personal injury settlement. One often overlooked strategy is to apportion part of personal injury settlement to past and future medical costs.
A plaintiff may allocate settlement proceeds to tax-free medical expenses even when the settlement is not based on a physical injury. For example, suppose a worker sustained emotional anguish due to workplace discrimination. In that case, they might allocate future and past medical expenses to treat mental health symptoms like anxiety, depression, and mood disorders.
Allocate All Damages in a Settlement Agreement
Allocating the personal injury settlement to different types of damages can result in substantial tax savings. For instance, the injured plaintiff might allocate part of a personal injury settlement as reimbursement of costs related to physical therapy and some for the emotional distress they suffered because of the defendant’s wrongdoing.
You can work with your personal injury attorney to allocate portions of your settlement in tax-free categories. You can use settlement negotiations to allocate a significant portion of your settlement to non-taxable award categories like physical injuries or illness.
Qualified Settlement Funds
Qualified Settlement Funds (QSF) provide a mechanism to defer tax payment on settlement proceeds. Once you establish QSF, the personal injury settlement is held in a trust, allowing you to defer tax liability to a later date.
QSF may be helpful for an individual with a complex settlement arrangement or ongoing litigation.
Seek Professional Advice
Tax regulations can be challenging, especially with personal injury settlements. Even so, seeking professional advice can help you take advantage of tax-saving opportunities.
For instance, a professional tax expert can help you understand various tax planning strategies, including the plaintiff recovery trust. The trust helps injured victims avoid paying double taxes by paying the levy on the amounts they receive rather than on attorney’s fees, as in other cases.
A personal injury lawyer can also take steps during the settlement process to limit tax liability for you. Consult a St. Louis injury attorney now.
Missouri and Illinois Personal Injury Attorneys | Burger Law
The personal injury claims process and legal precedent can be confusing for those without prior experience. At Burger Law, our wrongful death law firm has over 70 years of combined experience as trial attorneys, dedicated to securing the maximum compensation for our clients. If you’ve been injured due to someone else’s negligence in Missouri or Illinois, or if you have any questions about your claim, contact a Burger Law personal injury lawyer at [dynamic-phone-number] or reach contact us online.
The best way to ensure you comply with tax obligations after a personal injury recovery is by consulting a personal injury attorney and a tax professional. While determining the taxable elements of personal injury settlements is complicated, you may also face harsh tax penalties.
An attorney can apply their skills to maximize the settlement amount and help you comply with tax obligations.
