Will Your Personal Injury Settlement Be Taxed?

Injury Settlement

Here at BC Law Firm, we are dedicated to fighting on behalf of our clients to ensure they get compensated for accident claims by offering the best personal injury litigation services. We understand the importance of maintaining peace of mind to recover from any damages our clients have endured. Suppose you or someone you know has been physically injured in an accident. In that case, you may be wondering if that potential legal settlement will be taxed as income by the Internal Revenue Services (IRS). Before you file a personal injury claim, it is essential to know what type of legal settlements are subject to being taxed as income.

In the state of Florida, personal injury settlements are not typically taxed. However, every personal injury case is different, and settlement taxation varies from case to case. A personal injury lawsuit is normally qualified as a dispute where a person suffers harm or physical damages, and someone else is liable for the accident. In this case, the personal injury claim victim can usually seek compensation for the damages they sustained. Nonetheless, you should know that some legal settlements can be taxed as a person’s gross income when certain damages received during the injury are taxable. According to the IRS, lawsuit settlements are divided into one of two categories: nontaxable or taxable.

Personal Injury Settlement Agreements That You Do NOT Pay Taxes On

Any physical damages or sickness suffered as a result of an accident are typically excluded from federal taxes being owed on the legal settlement. Compensation for a claimant of bodily injury or illness is normally allocated to cover medical bills, pain, suffering, lost wages, loss of consortium, emotional distress, and attorney fees. Settlement payments from these types of claims are only tax-free if they result from personal injury or physical sickness. Any claimant of a personal injury lawsuit should receive the total settlement payout, only deducting attorney expenses or fees initially agreed upon by both parties. Should a claimant have any liens against them (unpaid medical expenses or child support dues), they will usually have the settlement amounts owed deducted from the nontaxable awarded settlement payment.

Nontaxable personal injury settlements usually include (but are not limited to): car accidents, truck accidents, motorcycle accidents, bicycle, and pedestrian accidents, premise accidents, slip/trip and fall accidents, animal bite accidents, burn accidents, and wrongful death claims.

Personal Injury Settlement Agreements That Are Not Exempt From Federal Taxes

Now, let’s say your attorney is also seeking punitive damages aside from the compensatory damages. He or she is likely to request the judge or jury to separate the verdicts for claims because the IRS taxes punitive damages settlements.

Punitive damages are assessed and bestowed upon the defendant of any lawsuit settlement that showed gross negligence and misconduct. These settlements are solely given to punish the defendant and deter them from making the same costly mistake. Any lawsuit settlement awarded to a personal injury victim for punitive damages will owe federal taxes on the lump sum. Personal injury claimants can use separate verdicts to demonstrate which part of their settlement is not taxable.

Say that you file a claim that you suffered a personal injury at some business establishment and lost wages due to emotional distress from the incident. Depending on the evidence of the claim, it may be hard for a judge to correlate the loss of wages to your sustained personal harm or illness. Any lost wages claimed are potentially subject to taxation because of the distinction between the two types of injuries outlined by the IRS.

Personal injury victims awarded punitive damages will be financially held liable to pay taxes on the total lump sum of monies awarded in the settlement agreement. For example, Lydia goes to court for her injury claim. She and her attorney agree to a 40%contingency fee that will be due when her settlement money is awarded. Should the court award Lydia $150,000 in punitive damages, she pays her attorney $60,000 ($150,000 x 40%, not taxed) based on their agreement. However, Lydia will owe federal taxes on the entire settlement amount of $150,000, not just the amount she took home after paying her attorney.

Other lawsuit settlement agreements subject to federal taxes include interest, emotional distress or mental anguish (not caused by physical injury), defamation, humiliation, and even lost wages.

Hiring a knowledgeable personal injury attorney that will fight for you to maximize the compensation owed and minimize tax liability that may be due is very important to get what is deserved.

How to Claim Your Personal Injury Settlement on Your Taxes

When it comes time to prepare your taxes, you should first and foremost seek the help of a professional accountant or tax professional for guidance. As previously mentioned, compensation for personal injury is not taxable and does not have to be claimed on your taxes.

But, if you received a settlement for personal injury or illness and medical expenses had to be deducted for any prior years (in the event the deductions provided a tax benefit), the portion allocated for the expenditure must be reported. For more information on how to calculate the amount to report, please refer to Publication 525 for Taxable and Nontaxable Incomes.

Any legal settlement for emotional distress, mental anguish, etc., that cannot be proven due to personal injury or sickness must be included in your income. According to the IRS website, one must include the amount awarded and reduce it by: (1) amounts paid for medical expenses that can be attributed to emotional distress and mental anguish had they not already been deducted and (2) previously deducted medical for such triggers that did not provide a tax benefit.

The IRS Settlements–Taxability states that a recipient of an injury settlement should attach a statement to the tax return to show the amount “less related to medical costs not previously deducted and medical costs deducted for which there was no tax benefit.” The net taxable amount (the value after expenses) should be reported as “Other Income” on line 21 of Form 1040, Schedule 1.

Punitive damages received from a legal settlement for personal injury or sickness should also be reported as “Other Income” when filing your taxes on line 21 of Form 1040, Schedule 1.

Lost wages awarded in a legal settlement payment are subject to Medicare and social security tax rates for whichever year they are paid. Furthermore, the proceeds are subject to any employment tax withholdings allocated by the payor of the lost wage. If you collected lost wages not linked to personal injury or sickness, they should be reported as wages, salaries, tips, etc., on line 1 of Form 1040.

Any interest that accrued on your legal settlement payment will typically be taxed as “Interest Income” and should be reported on line 2b of Form 1040.

For additional information on how to claim your taxable personal injury settlement payment, please refer to the guidance of a tax professional or accountant. For further information on the previously mentioned ways to report your settlement, read Publication 525, Taxable and Nontaxable Income, visit the IRS website, or give them a call toll-free at 1-800-829-1040.

Your friends and family at BC Law Firm are not versed in financial accounting or tax preparations. Any information provided to detail how to claim personal injury legal settlements on your taxes stems from our research and does not offer advice on the subject. This knowledge is general and does not take into account your objectives, financial situation, or needs.

We are a personal injury law firm that covers a wide variety of cases ranging from motor vehicle accidents, product liability, civil litigation, and more! For more information on our practice areas, please visit our website here.

If you or someone you know are personal injury victims and are ready to get the maximum compensation possible, please contact us today. BC Law trial lawyers are prepared to fight for you inside or outside of a courtroom to ensure you have the best possible settlement outcome and peace of mind to recover and heal.