Can a Personal Injury Settlement Be Taxed?

If you receive proceeds from settlement of a lawsuit, you may have questions about whether you must report the proceeds on your tax return. It’s a timely topic, as taxpayers across the nation are beginning to see tax documents like W-2s, 1098s and 1099s arrive in anticipation of tax season. Most of the time, no, you don’t have to pay taxes on personal injury settlements. However, there are many exceptions and situations where all or part of your settlement may be subject to income tax. If you must pay taxes on a lawsuit settlement, it is reported on Form 1040, line 21, as “other income.” These amounts are taxed at ordinary income rates, so the percentage depends on your tax bracket.

Whether you must include the settlement proceeds in your income depends on the facts and circumstances in your case. The Internal Revenue Service (IRS) says that you can’t be taxed on money from a settlement or jury award meant to compensate you for your physical injuries or the emotional distress or lost wages caused by those injuries. In sum, money received for economic damages like medical bills and lost income and for non-economic damages like pain and suffering is generally tax-free.

Depending on what decisions you made when filing your taxes in the past, you could still owe the IRS. There are exceptions to these general rules:

• If you receive a settlement for personal physical injuries or physical sickness, you must include in income that portion of the settlement that is for medical expenses you deducted in any prior year(s) to the extent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro rata basis the part of the proceeds for medical expenses to each of the years you paid medical expenses.

• Emotional Distress or Mental Anguish: If the proceeds you receive for emotional distress or mental anguish do not originate from a personal physical injury or physical sickness, you must include them in your income. However, the amount you must include is reduced by: (1) amounts paid for medical expenses attributable to emotional distress or mental anguish not previously deducted and (2) previously deducted medical expenses for such distress and anguish that did not provide a tax benefit. The IRS requires that you attach a statement showing the entire settlement amount less related medical costs not previously deducted and medical costs deducted for which there was no tax benefit.

• Punitive Damages: Punitive damages are taxable and should be reported as “Other Income” on line 21 of Form 1040, even if the punitive damages were received in a settlement for personal physical injuries or physical sickness.

• Interest Income: If you earn interest on any money recovered from your personal injury case, that interest isn’t tax exempt. This includes any interest your money earns sitting in a bank account as well as any investments you buy with your settlement money.

If your personal injury claim included both compensatory and punitive damages, it can be difficult for you to determine what portion of your settlement is taxable. Talk to an accountant for help, if necessary. Our attorneys have decades of experience providing exceptional representation to clients facing a wide range of claim issues. Contact us today at 786 Lawyers for a FREE consultation!