You’d be hard-pressed to find anyone who would prefer to pay more of their income to the federal government than necessary. Your goal as a taxpayer is typically to pay the IRS as little money as possible. As such, you may be wondering whether you have to report your personal injury settlement when you file your taxes this year. After all, if you’ve already been through the stress of an injury and a subsequent lawsuit, you’d hate for a portion of that compensation to be taken away by the government in the form of taxes.
Fortunately, if you’ve completed your case and received your settlement, the general rule is that the proceeds from a personal injury claim won’t be taxable under federal or state law. However, there are a few exceptions to the rule.
You’ve been through a devastating personal injury as a result of another person’s negligence. After fighting for your rights before or during trial, you sign the release, and your case is resolved. Now what? In a perfect world, you’ll get your money quickly and get back to living your life. However, there are certain scenarios in which you may have to give a portion of this revenue back to the government when you file your taxes.
The first question you have to ask yourself is whether your personal injury is related to a physical injury or sickness. For instance, did you break your leg or suffer a traumatic brain injury as a result of another at-fault individual? Were you negligently exposed to a virus or infection? If so, it doesn’t matter whether you settled the case before or after filing a personal injury lawsuit in court, nor whether you went to trial and won a verdict. Neither the federal government nor the State of California can tax you on the settlement or verdict proceeds in most personal injury claims.
In general, any portion of compensation received in a personal injury claim relating to a physical injury or illness can’t be taxed—as long as it relates directly to the injury or illness. For instance, if you were injured in a truck accident caused by someone else’s recklessness and received a settlement of $60,000 for your medical expenses, this will be nontaxable. If you also received an additional settlement of $10,000 for emotional distress because you lost your ability to live your life normally after the injury, this would also be nontaxable because it was directly related to your injury.
However, if you have a claim for emotional distress or employment discrimination that has nothing to do with a physical injury, your settlement or verdict would be taxable.
As stated, if your personal injury settlement doesn’t relate to a physical injury or illness, it will likely be taxed. Here a few additional instances in which your settlement will be taxed:
Even if you suffer a physical injury or sickness, you will be taxed on damages relating to a breach of contract if the breach of contract caused your injury and is the basis of your lawsuit.
In cases where the defendant’s conduct is deemed particularly egregious, a plaintiff may be awarded punitive damages on top of any compensatory damages. This money may be included to punish the defendants for intentionally harmful or careless behavior and discourage others from committing similar acts. Punitive damages are always taxable.
California may have court rules that add interest to the verdict for the length of time your case has been pending. The amount of compensation received in a personal injury settlement attributed to interest is generally taxable.
Tax law is a complex subject, and the laws governing personal injury settlements and related taxes can be especially tricky. Because thousands of dollars could be at stake, you need a lawyer who can help you allocate your settlement so that you have to pay as little in taxes as possible. Fortunately, the experienced attorneys at Danko Meredith are here to assist you.
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