Any income you receive throughout the year can affect your taxes. Do you have to claim that income on your taxes if you receive a large lump sum settlement or periodic payments from a personal injury claim payout? Additional tax burdens could substantially limit your funds as you might have to spend a large percentage of a lump sum award on taxes.
The IRS has several complicated tax regulations that may apply to your settlement. Contact an experienced personal injury lawyer in your area for more information on your unique situation.
Personal Injury Settlements and the IRS: What You Need to Know
As a general rule, personal injury settlements compensate people for expenses caused by another person’s negligence. In many cases, the IRS does not require victims to claim the funds from a settlement as income. However, the IRS has strict rules governing how you must handle settlement income while preparing your taxes.
Compensation for Medical Costs
Following most injury settlements, you do not have to claim compensation for your medical expenses on your taxes. However, the IRS notes that you may need to look back at the previous year’s taxes to determine what you may need to include. Did you deduct medical costs from your taxes in the prior year and receive a tax benefit for them? If so, you may need to claim a percentage of the proceeds based on the IRS requirements.
Compensation for medical costs may include all the compensation issued for medical bills related to your accident, including:
- Emergency care
- Long-term care
- Durable medical equipment
Talk to your lawyer about what portion of your settlement directly counts as compensation for medical costs. You may also want to work with a tax preparation professional to ensure that you fully understand how your settlement could impact your taxes and what you may need to claim.
Compensation for Property Damage
If you receive compensation for damaged property, like a damaged vehicle after a car accident, those damages generally do not count as taxable income. However, if you receive more compensation than the value of the damaged property, you may need to claim that percentage of the settlement as part of your income.
Compensation for Lost Wages in Personal Injury Lawsuits
If you receive compensation for the income you lost because of your injuries, you typically do not have to count it as taxable income. Most injury settlements do not break down the components of the award.
Instead, most people receive a lump-sum payment to cover pain and suffering, medical costs, and lost wages following the accident. Because you cannot reasonably break down the settlement into specific compensation, whether you receive periodic payments or a single payment, you will not usually have to claim those payments as income.
Compensation for Pain and Suffering Following an Injury
Many injury settlements also include general damages or compensation for pain and suffering. The IRS does not differentiate between the portion of the settlement awarded for medical compensation and the portion awarded for pain and suffering. As a result, you will likely not have to pay taxes related to general damages.
Workers’ Compensation Claims and Settlements
Workers' compensation funds usually do not count as taxable income. You will generally receive direct payment for your medical bills through your workers' compensation coverage, which means you will not have to move those funds through your financial accounts. However, in some cases, you may receive a lump-sum settlement or periodic payout due to permanently disabling injuries.
In that case, the funds would not count as taxable income. However, as with an injury claim, if you claimed the medical expenses related to those injuries on your taxes and received a tax benefit for that claim, you may need to claim the percentage of that settlement that makes up the tax difference. Talk to a lawyer or tax professional for more information about your specific tax burden.
Wrongful Death Settlements
Like personal injury claims, wrongful death claims and the associated settlements count as non-taxable funds, according to the IRS. Because those funds aim to provide direct compensation for the financial losses that often accompany the loss of a loved one, the IRS does not acknowledge them as taxable income.
Emotional Distress Unrelated to a Physical Injury or Illness
In some cases, you may file a claim based purely on emotional distress an accident caused. While you may not have to claim funds awarded based on the treatment cost for disorders like anxiety, depression, or PTSD, you may have to claim compensation for emotional distress alone.
Lost Wages Unrelated to an Injury Claim
Some types of lost wage payments will count as income when you file your taxes that year. For example, suppose you receive a payment from an unlawful termination lawsuit or a discrimination lawsuit. You might receive a specific settlement to replace lost wages, including back pay or severance pay. Generally, that settlement amount will count as taxable income, according to the IRS, and you will need to report it on your taxes and handle it accordingly.
In some cases, the court may assign punitive damages to the party that caused your injuries. Generally, punitive damages occur in cases of gross misconduct or negligence. For example, a company that hides a potentially dangerous product or that pushes a product to market without testing it may end up paying punitive damages. Drunk drivers who cause catastrophic accidents may also pay punitive damages as part of the retribution process.
Punitive damages usually get handled separately from an injury claim. While insurance companies often pay out personal injury claims, punitive damages are typically paid directly by the liable party. As a result, they do not fall directly under the personal injury claim. The IRS does note that any punitive damages count as taxable income and that you must claim them accordingly.
Sometimes, the liable party, or the liable party’s insurance company, may not have the ability to immediately pay out the compensation you deserve for an injury claim. You may have to wait months or even years to receive the full proceeds from a claim. In the meantime, that claim may continue to collect interest. Interest payments made on the initial settlement amount count as taxable income, though the initial settlement will continue to count as non-taxable funds.
How Do I Know if I Have to Claim a Settlement as Income?
Most of the time, following a personal injury claim, you will not have to claim the funds received as part of your settlement as income. Those funds count as compensatory damages, and you will not bear a tax burden on them. However, according to the IRS, some parts of an injury claim, including punitive damages, may count as income.
In addition, you may have to consider the source of your settlement. For example, if you claim emotional distress alone as the foundation of your injury claim, you may need to claim those funds as income.
If you have questions about whether a settlement will count as income, make sure you talk to your lawyer.
Does a Settlement Count as Income for Disability Payments?
Receiving a settlement for an injury, including the condition that caused you to have to go on disability in the first place, will not typically impact your disability payments. The program generally sees the funds from an injury claim as compensatory damages intended to help you cover the often high expenses that may accompany your injuries, so you will not have to worry about your benefits disappearing because of a settlement.
However, in some cases, like workers’ compensation payouts, if the entire settlement pays for lost wages due to your injuries, the Social Security Administration may temporarily suspend disability payments. Make sure you talk to your lawyer about how your settlement could impact your SSDI income to plan accordingly.
How Can You Minimize Tax Implications From a Personal Injury Settlement?
You do not want to lose more of your settlement to taxes than necessary since you may need to use those funds to cover your medical expenses and make up for financial difficulties you face following your accident.
Talk to your lawyer to learn how to manage your specific claim to minimize any potential tax burden that might accompany your injuries.
- Think ahead when filing your taxes after an injury. After a serious injury, you may want to claim any medical bills you have paid on your taxes to experience the tax benefits. However, if you experience tax benefits from those bills now, it may increase your tax burden after receiving a settlement. Talk to your lawyer about how to manage your taxes following the accident. You may need those funds while waiting for your claim to settle, or you may decide that it makes more sense to leave your medical bills off your taxes so that you do not have to deal with tax implications later. Taking a future-minded view of your taxes and your claim can make it easier to manage the many financial challenges that often arise.
- Categorize your award appropriately. When filing taxes, categorize your damages properly. While some types of damages, including punitive damages, may count as taxable income, personal injury damages may not count as income for taxation. Correctly categorizing these awards can save you money in the long run.
- Understand your potential tax liability. Talk to your lawyer about the potential tax liability associated with your claim. When you know what compensation to expect and what taxes you anticipate, you can often make a more effective decision about handling your finances before and after receiving a settlement.
Contact a Lawyer Today to Learn More About Personal Injury Claims and Tax Implications
Do you have questions about your personal injury claim, including how much of your settlement you might need to report as taxable income? A lawyer can guide you through the process and better understand how to protect your finances. Contact a personal injury lawyer near you to learn more.