Is My Personal Injury Settlement Taxable?
Taxes are complicated under the best of circumstances, and even more so after an accident. Are personal injury settlements taxable? Including a personal injury settlement in your annual income may leave you at a loss – literally. Because some personal injury settlements are sizable enough to put you into a new tax bracket, a settlement’s inclusion may see you pay out more money than you take in.
That said, your taxes don’t have to be an unbearable burden. Nor does the Internal Revenue Service (IRS) have to intimidate you. Whether you’re still in the midst of a suit or coming away from a claim, our personal injury attorneys can help you make sense of your post-case finances.
What does the IRS Say?
When debating how a settlement impacts your taxes, the IRS is your best resource. The IRS outlines settlement taxability in Publication 4345. Here you’ll find what parts of your settlement are taxable, which are not, and what exceptions there may be to the rule.
That said, the 2017 Tax Cut and Jobs Act modified taxes on personal injury lawsuit settlements. In most cases, this act declares that the person who receives compensation must list pre-contingency compensation alongside their year-end income. In other words, you may not subtract an attorney’s fees from your settlement before listing it.
Unfortunately, the 2017 Tax Cut and Jobs Act may put many people receiving a case settlement under a significant amount of financial pressure. You can discuss both the role of contingency in your case and a settlement’s taxability with an attending attorney. Together we can work out how best to protect the financial support you fought so hard for.
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Your Taxable Settlement Income
Depending on the circumstances surrounding your case, there may be parts of your settlement that the federal and state government opt to tax. You’ll need to know what parts of your settlement these include so that you can adequately prepare your year-end returns (and your bank account).
Pain and Suffering Without Injury
If you did not suffer a physical injury or illness before filing your case but still received pain and suffering damages, there’s a good chance that any settlement you receive will be taxable. You should add your non-economic damages to your year-end income while discussing what deductions you’re eligible for with an accountant.
If you receive the equivalent of back pay in a case settlement, be prepared for that pay to be taxed. You’ll need to work with a third party to calculate back pay taxes and avoid trouble with the IRS.
You cannot request punitive damages when you take a personal injury case to court. Instead, a judge can choose to add punitive damages to your case. Most courts opt to do this if it appears you or a loved one suffered from gross negligence or recklessness.
While these damages can grow your personal injury settlement, they are also taxable. Come the end of your year, you’ll need to include punitive damages as part of your income. This is the case regardless of whether or not you were injured by the incident that prompted your case.
Some personal injury claims can last longer than a year. While your case is ongoing, you can list your accident-related expenses, such as medical costs, as deductions. However, once you’ve received your settlement, you may have to pay those deducted expenses back.
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Your Non-Taxable Settlement Income
If you suffer physical loss, illness, or similar condition in an accident, you do not have to pay taxes on your personal injury settlement. More specifically, the compensatory nature of these damages allows you to disinclude the following from your year-end income:
- Medical expenses
- Property repairs or replacement
- Legal fees related to your case
- Reduced quality of life
- Emotional distress
- Loss of consortium
Physical injuries can keep your year-end taxes more bearable in these circumstances. If you’re not sure as to whether or not your settlement falls within the compensatory category, sit down with an attorney. Both attorneys and accountants can help you stay on the IRS’s good side.
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Other Non-Taxable Settlements
In a similar vein, there are certain personal injury settlements that are not taxable, regardless of whether or not the person in question endured a physical injury. These include:
Wrongful Death Settlements
Wrongful death suits filed by a personal representative indicate a true tragedy within a family. It’s with the injuries that the deceased suffer in mind, alongside injuries endured by the family, that wrongful death settlements are not taxed on a federal or state level.
That said, if a judge opts to award a family punitive damages after a wrongful death, your situation may be different. As mentioned, punitive damages are always taxable. While you can deduct compensatory damages from your year-end income, you’ll want to work with a wrongful death attorney to appropriately account for these additional damages.
The federal government has also introduced a tax break that declares certain forms of workers’ compensation non-taxable. You’ll need to determine whether or not your case falls into this category before tax season rolls around.
You do not have to list your workers’ compensation settlement alongside your annual income if your case involves a work-based illness, injury, and/or related medical expenses. Any retirement benefits or interest involved in the case will also remain tax-free.
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The IRS’s Percentage of Claim
The amount of your settlement that the IRS requests aligns with your tax bracket. In April of the coming year, you’ll include the settlement among your base income. Then, based on the tax bracket you land in, you’ll pay a percentage of your income back to the federal and state governments using the standard forms.
For example, say you make an average of $45,000 per year. The year you file for compensation, you receive a settlement totaling $200,000. So long as your settlement is taxable, you’ll list your total income for the year as $245,000. In turn, you’ll be taxed at a 35% tax rate instead of your usual 22% rate.
For more information about your variable tax bracket, you can turn to an attorney or to one of today’s many tax bracket calculators.
Personal Injury Settlements and Your Health Insurance
The amount of assistance you receive while paying for healthcare under the Affordable Care Act is based on your yearly income. When you first register for this support, you’re expected to include an estimate of your income. If you underestimate your income due to your receipt of a settlement offer, you may have to pay additional taxes in the year to come.
Fortunately, you have time to adjust your expected income. If you do receive a personal injury settlement, go to healthcare.gov and indicate an unexpected life change. The federal government can then adjust your monthly fees and help you avoid tax fees.
That said, don’t panic if you aren’t able to adjust your income in time. While you will have to pay back a percentage of your forgiven premium, the Affordable Care Act caps the amount it can charge you at 8.5% of your total household income.
Contact a Personal Injury Lawyer for Help
When you submit your tax forms this year, you need to be sure that you’ve fulfilled all your financial obligations to both the state and federal governments. If you’ve received a personal injury settlement within the past tax year, a personal injury lawyer can ask a judge to separate compensatory and punitive damages. This way, filing your taxes will be easier.
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