Generally, the IRS does not tax personal injury settlement payments as they are not considered to be a wage or salary. Nonetheless, there are notable exceptions.
It is important to find out whether your compensation amount or portions of it are taxable. This will help you determine the impact on your total amount. It will also protect you from paying the penalty on unreported taxable income.
Not sure if portions of your settlement are taxable? An expert Los Angeles Personal Injury Attorney with El Dabe Ritter Trial Lawyers can review your case and advise you accordingly.
The General Rule
Generally, personal injury settlements are not taxable under state or federal law. This rule applies to awards given by a jury or judge and insurance proceeds. It also only applies to physical injuries and related expenses.
In a nutshell, damages paid to cover any losses caused by personal injury or physical sickness are non-taxable. These include damages such as:
- Medical bills — These are expenses covering diagnosis, treatment, mitigation, or prevention of a medical condition.
- Lost wages
- Loss of consortium
- Lost earning ability
- Pain and suffering
- Attorney fees
That said, as with every rule, there are exceptions.
Exceptions to the General Rule
The key to non-taxable compensation is physical harm. The term can be defined to include illness, internal organ damage, infections, or surgery. However, it does not cover emotional or mental distress.
For instance, a purely psychological injury is not physical harm. However, pain and suffering arising from a bodily injury fall under the term.
This means that if your case does not involve corresponding physical injury, your settlement could be subject to taxation. Other situations where your compensation may be taxed include:
- Interest on the Judgment: In some states, the court adds interest to the verdict for the duration the case has been pending. This amount is counted from the day you file your suit to when you receive payment. It could also extend to cover the time taken by the defendant to appeal. This interest is taxable.
- Punitive Damages: Punitive damages are aimed at punishing the defendant for gross misconduct. They are always taxable. Consequently, most personal injury attorneys tend to request a separate verdict on punitive damage claims. This helps protect the non-taxable portion of your settlement from interference by the IRS.
- Breach of Contract: Even if you can prove physical harm, your settlement could be taxed if a breach of contract caused the injury or illness. This is especially true when your lawsuit is based on the breach.
- Employment-Based Claims: Claims such as illegal discrimination, lost wages, back wages, or emotional distress don’t involve physical injury. This means that they are taxable unless you can prove bodily injury.
- Other Exceptions: You could get taxed on physical injuries if you already deducted the cost of the injuries in a previous tax year. This is rare as it usually only applies in lawsuits that happen months or years after initial care.
Contact a Los Angeles Personal Injury Attorney
The personal injury attorneys at El Dabe Ritter Trial Lawyers are well versed in the issue of injury settlement taxation. We employ our expertise in helping our clients maximize the non-taxable faction of their settlement.
We understand that each personal injury settlement is unique. If you would like us to review your case, contact the offices of El Dabe Ritter Trial Lawyers to speak to an expert Los Angeles Personal Injury Attorney.