Are personal injury claims taxable? Or more precisely are proceeds received, either by settlement or verdict, from a personal injury case subject to tax – this is one of the most common questions we get as personal injury lawyers. The answer, like many questions in life, is a resounding maybe. After being injured due to someone or some entities negligence, getting medical attention, dealing with the pain and suffering, and finally receiving some sort of financial compensation either by settlement or verdict you are now left with the question about taxes.
A personal injury settlement can be non-taxable, partially taxable, or fully taxable dependent upon the type of case and compensation. Whether or not your claim is taxable depends on if there was a physical injury or physical sickness. The Internal Revenue Service (IRS) has many different guidelines. However, there is still some confusion as to which injuries are subject to be taxable.
One important point before getting into the nuts and bolts of the personal injury proceeds tax issue – we are Philadelphia area personal injury lawyers and by no means claim to be tax professionals, every persons tax situation is different, and you should always consult with your own tax professional before making any decisions.
Which Does the IRS have to Say?
The IRS states that “All income is taxable from whatever source derived unless exempted by another section of the Code” – IRC Section 61. However, there is an exception for some personal injury claims. The IRS regulation touches on if personal injury settlements and verdicts are taxable – this is the 26 C.F.R 1. This states in part:
(c) Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.”
IRS Taxable Guidelines
The IRS has some guidelines in which a personal injury settlement would be excluded from income taxes.
Generally, you will not be taxed on money received from a personal injury claim or jury award for the following:
- Physical Injury
- Emotional Distress caused by Physical Injury
- Lost Wages resulted from Physical Injury
What is Considered Taxable and Tax-Free?
- Punitive Damages – if you receive punitive damages and compensatory damages, the two should be separated so you can distinguish them on your tax form.
- Interest on Judgement – Interest received for any length of time on a pending case is subject to taxes.
- Emotional Injury Only – This is unless you can show that you received some sort of physical injury.
- Breach of Contract – This goes for physical injury and sickness if the breach of contract, in fact, caused the injury.
- Compensation for lost income caused by physical injury
- Compensation for physical injury and sickness
- Compensation for medical costs
- Compensation from emotional distress caused by physical sickness and injury
Physical Injuries and Sickness
Up until the year 1996, those who received personal injury settlements, whether it be emotional or physical were considered tax-free. However, since then, the laws have changed. Typically, physical injuries and sickness is not taxable and does not need to be reported on your tax return. However, if you deduct medical expenses on any previous tax return, the money in which you deducted is then considered taxable. Also, any attorney’s fees that are related to a financial settlement because of physical injuries or physical sickness will also be regarded as non-taxable.
Claims for Emotional Distress or Mental Anguish
If you received a financial settlement because of emotional distress or mental anguish – this could also be tax-free. In this case, the mental anguish or emotional distress was related to the injury or sickness, and this would be titled as medical. However, if you have a claim for emotional distress or employment discrimination, but you did not receive any injury, then any settlement you receive would be taxable.
Are Punitive Damages Taxable
It is rare to receive punitive damages resulting from a personal injury claim. However, if you do receive punitive damages, these situations are taxed differently. With financial settlements received from punitive damages, the money in which you receive is not for compensation. Instead, it is intended to punish the at-fault individual.
Punitive damage settlements are not compensatory, including receiving punitive damages in a personal injury claim that is subject to be taxed. If you do not include this income on your income tax form it can cause other troubles in the future. When reporting this income, you will need to enter the amount on your 1040 Form as “Other Income.”
Is Property Damage Taxable
Typically, property damage settlements are not considered to be taxable. The IRS states that if you lose value in your property, and it is less than the basis of the property, then the settlement is not taxable. This is done to help lower the basis from the property by the sum of the settlement.
What this means is if your settlement is more than the basis of your property, the rest of the settlement is considered income.
Compensation for Lost Business or Income
Lost business or income in a personal injury case is considered nontaxable. This refers to the 26 U.S.C. § 104(a)(2) and Commissioner of Internal Revenue v. Schleier, 515 U.S. 323, 329-30 (1995). However, if the injuries are based on emotional distress, a verdict or settlement from loss of wages or business income can be taxable on the Federal level.
How Can a Personal Injury Lawyer Help with Taxes
After receiving your settlement, it is important to know if your settlement is subject to any taxes. There can be cases where you can recover for multiple causes of action against differing parties. It is important to have the release and/or settlement statement account for which amount is for personal injury and which is for non-personal injury. An experienced accident lawyer can make sure that the settlement is detailed properly to ensure you have the least tax burden from your personal injury settlement. When a personal injury case is taken to trial and a verdict is reached the judge and/or jury get to award the damages and can have a tax impact on how much money you ultimately end up with. The bottom line is working with an excellent Pennsylvania Personal Injury Attorney can help ensure you take the most money home after your injury case is resolved.