Are our personal injury claims taxable? One of the most common questions we get as personal injury lawyers is: are proceeds received from a personal injury case subject to tax, either by settlement or verdict? The answer, like many questions in life, is a resounding maybe. After being injured due to someone or some entity’s negligence, getting medical attention, dealing with the pain and suffering, and finally receiving some financial compensation either by settlement or verdict, you are now left with the question: “Is my personal injury claim taxable?”
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 about which damages are subject to taxes.
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 person’s tax situation is different, and you should always consult with your own tax professional before making any decisions.
IRS Taxable Guidelines
The IRS has some guidelines for a personal injury settlement that 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- Money obtained to compensate for broken bones, surgeries, herniation, etc.
- Emotional distress caused by Physical Injury – Money received for mental distress or mental anguish.
- Medical Expenses – Unless you a deduction for that money on your previous year’s income tax return
- Lost Wages resulted from Physical Injury – Interestingly enough, even though you would have been taxed had you worked for the money, this recovery is tax-free. However, this changes in suits for employment-related lawsuits
What Personal Injury Claims are Considered Taxable and Tax-Free?
Below are a few guidelines to help us determine whether your personal injury claim is taxable.
Taxable Claims:
- 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 on a pending case is subject to taxes for any length of time.
- Emotional injury Only – Only if you can show that you received some physical damage.
- Breach of Contract – Physical injury and sickness if the breach of contract caused the damage.
Tax-Free Claims
- Compensation for lost income caused by physical injury
- Compensation for physical damage and sickness
- Compensation for medical costs
- Compensation from emotional distress caused by physical illness and injury
Types of Personal Injury Awards that ARE Taxable:
- Legal Injuries – These are personal injuries that arise from harassment, discrimination, libel, etc., not personal physical injuries
- Punitive Damages – These awards are rare, usually in the realm of products liability, and are meant to punish the wrongdoer through monetary penalty. One exception to the punitive award being taxed is a particular case of wrongful death, where the State law only will allow for this type of damage.
Physical Injuries and Sickness
Until 1996, those who received personal injury settlements were considered tax-free, whether emotional or physical. However, since then, the laws have changed. Typically, physical injuries and sicknesses are not taxable and must be reported on your tax return.
However, if you deduct medical expenses on any previous tax return, the money you deducted is then considered taxable. Also, any attorney’s fees related to a financial settlement because of physical injuries or physical sickness will be regarded as non-taxable.
Claims for Emotional Distress or Mental Anguish
This could also be tax-free if you received a financial settlement because of emotional distress or mental anguish. In this case, the mental suffering or emotional pain was related to the injury or sickness, considered medical. However, if you claim emotional distress or employment discrimination but did not receive any damage, then any settlement would be taxable.
Are Punitive Damages Taxable
It is rare to receive punitive damages resulting from a personal injury claim. However, if you receive punitive damages, these situations are taxed differently. For example, with financial settlements received from punitive damages, your money is not for compensation. Instead, it is intended to punish the at-fault individual.
Punitive damage settlements are not compensatory, including punitive damages in a personal injury claim subject to tax. 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 foundation from the property by the sum of the payment. 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 non-taxable. This refers to the 26 USC § 104(a)(2) and Commissioner of Internal Revenue v. Schleier, 515 US 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.
Importance of Taxes in Your Personal Injury Case
Understanding the tax implications on your personal injury settlement is important because it can help you decide whether or not you should accept an offer and determine the actual cash value of your injury case. As a Top Personal Injury Law Firm we always try to give our injury clients the big picture view of their case.
Weighing the risk/reward, and explaining all the factors, including tax (or lack thereof) for all our personal injury clients, helps us determine the best course of action for your case and obtain maximum dollars for your injury. An important point to remember, we are personal injury lawyers and not tax professionals.
There are exceptions to the general tax rules noted above (and other more intricate tax points not discussed in this blog post). We always suggest consulting with a tax professional about your injury settlement money before filing your taxes.
Resources: Taxes and Personal Injury Settlement
- IRS Publication 4345 – Settlement Taxiblity
- IRS Publication 525 – Taxable and Non-taxable Income for 2014
How Can a Personal Injury Lawyer Help with Taxes?
After receiving your settlement, it is essential to know if your compensation is subject to any taxes. There can be cases where you can recover for multiple causes of action against differing parties. It is essential to have the release and settlement statement account for which amount is for personal injury and non-personal injury.
An experienced accident lawyer can ensure that the settlement is detailed correctly to ensure you have the least tax burden from your confidential injury settlement. When a personal injury case is taken to trial, and a verdict is reached, the judge and 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 make the most money home after your injury case is resolved. Give us a call at (215) 939-4895 or fill out our online form.
