You’ve endured months of legal back-and-forth and finally received a personal injury settlement. It’s a moment of relief, until you hear that the IRS may take a chunk of it.
Then, comes the question: Are personal injury lawsuit settlements taxable? Does the IRS tax personal injury settlement money?
These are some of the most common questions injury victims like you in Missouri ask. The answer to this question isn’t always straightforward because settlement money often includes different components, and while some of these may be tax-free, others can be subject to taxes.
This “personal injury settlements and taxes”
Taxable vs. Non-Taxable Personal Injury Damages
Non-taxable personal injury damages refer to settlement money from a personal injury claim that is not subject to taxes. Generally, a personal injury settlement is non-taxable if the case involves observable bodily harm. The damages recovered are not considered income, but as compensation for the physical injury.
On the other hand, taxable personal injury damages refer to settlement money from a personal injury claim that is subject to taxes. You need to include this money in the income section of your tax form and pay income tax on it.
Different Types of Non-Taxable Personal Injury Settlements
Personal injury settlements (or parts of them) related to physical injury or physical sickness are tax-free. Specific examples of non-taxable personal injury settlements are:
Medical expenses
Damages received from a personal injury claim to cover hospital bills or the cost of physical therapy are non-taxable.
Pain and suffering (related to physical injury)
Damages received from a personal injury claim as compensation for pain and suffering because of a physical injury or illness are non-taxable.
That is, pain and suffering (or emotional distress) must result from a physical injury or illness for damages recovered to be non-taxable.
For example, a model got in an auto accident and scarred her face, then suffered emotional distress as a result. The award for pain and suffering will not be taxable. However, if someone maliciously spread a rumor about you, and you suffer emotional distress as a result, the award for pain and suffering will be taxable, as there was no related physical injury.
Lost wages (related to a physical injury or illness)
Damages received for lost wages when recovering from a physical injury or illness are non-taxable.
For example, you broke your leg in a car crash in Kansas City and missed work as a result. Any award recovered to cover the wages you lost is non-taxable.
Different Types of Taxable Personal Injury Settlements
Parts of personal injury settlements that are not directly tied to physical injuries or illnesses are taxable. Specific examples of taxable personal injury settlements are:
Emotional distress
Any settlement recovered for emotional distress that is not as a result of a physical injury or illness is taxable. These include settlement for emotional distress due to workplace harassment, defamation, invasion of privacy, wrongful termination, or breach of contract. Since there was no physical injury involved, the money is taxable.
Punitive damages
Punitive damages are often included in personal injury settlements to punish the defendant when their conduct is deemed egregious. These damages are taxable.
That is, when settlement money includes compensatory and punitive damages, the compensatory damages part is not taxable (if related to a physical injury or illness), but the punitive damages part is subject to income tax.
Interest on a settlement
In certain cases, especially those that take several years, the award may include interests that accumulated between when the damages were awarded and when the plaintiff actually received the compensation. This interest amount is taxable.
For example, after being awarded $100,000 in damages in a personal injury case, the defendant contested the award. Three years later, the court ruled that the award stands and added $5,000 in interest for the delay in getting paid. Even if the $100,000 is non-taxable (for being compensation for a physical injury), the $5,000 interest amount is taxable.
Previously deducted medical expense
Awards for medical expenses are generally tax-free. But if you’ve previously deducted these expenses in your taxes, any personal injury award for them will be taxable.
For example, you’re hurt in a car accident in Missouri and pay $10,000 out of pocket for medical treatment. Then, when filing your taxes for that year, you deducted $10,000 as medical expenses. If you later win the personal injury case and are reimbursed for the out-of-pocket medical expense, this amount is taxable because you’ve already gotten a tax break for it.
What You Should Know Before Filing Taxes After a Personal Injury Payout
Receiving a personal injury settlement means you’ve closed a difficult chapter. But to avoid surprises from the IRS, here are a few things to know before the tax season comes around:
- Not all settlement money is tax-free
You’ll not pay taxes on settlement money that is compensation for medical bills, damages for pain and suffering linked to a physical injury, or damages for lost wages due to a physical injury.
However, some components of the settlement money may be taxable, such as emotional distress not tied to physical injury or illness, interest awarded on the judgment, or damages for lost wages not related to physical injury.
- Previously deducted medical expenses are taxable
If, in a previous year, you claimed a tax deduction for medical expenses related to your injury, any reimbursement for this expense in a settlement is taxable.
- Attorney fees can affect your taxable amount
In some cases, you may have to pay tax on personal injury settlement, even if a big chunk of it went to your attorney.
For example, consider that you’re awarded $500,000 as punitive damages, but $200,000 of this goes to your attorney. Though you actually get only $300,000, you may be told to pay personal injury settlement tax on the whole $500,000.
- Don’t ignore the Form 1099-MISC
If any part of your settlement is taxable, the defendant’s attorneys will send you the Form 1099-MISC. If you got this, the IRS also got a copy. So, ignoring it can make the IRS flag your return, which will trigger an audit or penalty. Instead, ensure the stated amount on the form aligns with the taxability of your specific damages.
When to call an accountant or attorney
When filing taxes after a personal injury payout, consider contacting an accountant or attorney
- You received a 1099-MISC, but are not sure of what it includes.
- The insurance company misclassified non-taxable damages as taxable in the Form 1099-MISC.
- Your settlement has many components, and you’re unsure of what’s tax-free and what isn’t.
- You’re unsure of how attorney fees affect your tax amount.
Final Notes on Personal Injury Settlements and Taxes
Now you know the answer to the popular question, “Is a personal injury settlement taxable?”
Taxes on a settlement for personal injury depend on how the settlement is structured. Remember that just as every personal injury case is different, so is every settlement.
However, if you’re unsure about what to report, experienced personal injury lawyers can guide you.
Book a free consultation and see how Royce Injury Lawyers can help you maximize your settlement money and minimize your personal injury tax obligation.
He has founded multiple law firms and has personally represented over 20,000 clients. His firms have helped over 250,000 clients.
At Royce Injury Lawyers, personal injury law is all we do. Whether you've been hurt on the job, had an auto accident, nursing home injury, or experienced medical malpractice, you can count on our attorneys and investigators to work for you.
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