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Is My Personal Injury Settlement Taxable?

It is important to find out whether you need to pay taxes on a personal injury settlement in Virginia. Failing to account for tax liabilities could lead to trouble with the Internal Revenue Service (IRS) or state government. This is a potentially criminal mistake. 

Work with an attorney to learn about the taxation of your settlement and how it affects your earnings. Each case is unique, and the laws are constantly changing. However, a few general principles apply to most injury settlements under the latest tax laws.

What Does the IRS Say?

The first place to turn to for any tax questions is the IRS. Their language may be hard to understand, but they are the ones who hold the cards. We recommend starting with Publication 4345 as a starting point.

We also recommend speaking with a CPA after you win your award as soon as possible. They will tell you how much to set aside for taxes. It would be tragic to spend all of your settlement on expenses and then get hit with an enormous tax bill next year.

Compensatory Damages: Nontaxable (Usually)

Most plaintiffs will not have to pay any state or federal taxes on their personal injury settlements. Settlements for losses related to physical injuries or illnesses, such as broken bones, head injuries, brain damage or spinal cord injuries, are tax-exempt. 

You will not owe taxes on parts of a settlement that pay for medical expenses, property repairs, legal fees, lost quality of life, emotional distress, loss of consortium or wrongful death. Federal tax law prohibits the taxation of these parts of your settlement.

The only nontaxable compensatory awards come from lawsuits involving a plaintiff’s physical injury or illness. However, other types of awards may be taxable. Here are some examples.

Pain and Suffering Without Injury: Taxable

If you receive compensation for only pain and suffering, however, without an accompanying physical injury or ailment, this settlement will be taxable. Pain and suffering damages without physical injuries are exceptions to the government’s rule not to tax injury settlements.

For example, if you witnessed your loved one die in a pedestrian accident, but did not suffer any physical injuries yourself, you would owe taxes on any money you receive for mental anguish or emotional distress.

Lost Wages: Taxable

In most cases, you will owe taxes on any compensation you receive to make up for lost wages. Receiving pay as a settlement does not exempt you from your standard income tax liability. 

You would have had to pay taxes on your income had you been able to go to work normally, so you must pay them on your settlement. You will still need to pay taxes on the wages you receive through a personal injury award.

Punitive Damages: Taxable

The IRS always taxes punitive damages in a personal injury settlement, no matter the type of claim. You will owe taxes on any part of your settlement that is a punitive award, according to federal tax laws. Punitive damages are somewhat rare in personal injury claims. 

They are a type of award a judge can assign during cases involving a defendant’s gross negligence, recklessness, wanton disregard for the safety of others or intentional misconduct. Assigning punitive damages is a punishment that forces the defendant to pay extra for your losses. 

If a judge grants you punitive damages, you must pay taxes on this portion of your settlement. If your personal injury settlement involves interest from the defendant, this part of your award will also have tax liability.

Deducted Expenses: Taxable

Some personal injury claims can last longer than a year. If you previously listed your accident-related expenses, such as medical costs, as deductions when filing your taxes, you must pay taxes on those deductions after receiving your settlement. 

The federal government will not allow you to receive double tax benefits on the same sum. If you already benefited from a tax deduction, therefore, you cannot also benefit from avoiding tax liability on this part of your personal injury settlement.

Damages From Lawsuits Without Injuries: Taxable

Other civil claims that do not involve physical injuries, such as business disputes or wrongful termination lawsuits, also do not fall under the umbrella of no tax liability. You will have to pay taxes on any settlement you receive in these types of cases.

Even if a situation caused you to receive a physical sickness or injury, if your lawsuit isn’t about your physical harm, then any compensation is taxable. One instance might be suing over a contract breach that made you ill, but the suit is focused on the contract.

Health Insurance Questions

If you have health insurance under the Affordable Care Act (Obamacare), there is another snag you must know about. Your settlement money may count as income for the purpose of tax credits from using the marketplace.

If you win an award, you’ll need to adjust your income as soon as possible at healthcare.gov. If you don’t, your tax credit amount may be more than what you should get based on your additional income. This will cause tax penalties.

Contact a Lawyer For Help

Work with an attorney to make sure you fulfill all your tax obligations under federal and state laws. A personal injury lawyer can ask a judge to separate compensatory and punitive damages in your settlement award to make filing your taxes easier. 

A personal injury lawyer in Richmond can also help you minimize your tax obligation and pay the correct parties upon settling. Hire an attorney as soon as possible after a personal injury for advice you can trust.