It may seem strange talking about taxes in August, but personal injury settlements can take many months to resolve. Therefore if you are embroiled in a personal injury case right now, you may receive your compensation at any point during the year. As these settlements often involve large dollar amounts received in a lump sum or installments received over the course of years, it is important to understand the tax implications of your reward.
The quick answer is that the majority of personal injury settlements are not considered taxable under state or federal law. However, there are some circumstances that may result in tax liability – and not understanding your tax obligations could result in severe penalties.
When you retain an experienced Florida personal injury attorney, he or she can provide guidance as to the tax aspects of your personal injury claim. This information will be essential to understand when deciding on whether any offered settlement is acceptable to you or not. You may also wish to consult with your personal tax attorney or financial professional throughout the process.
Non-Taxable Compensation
In most cases, the Internal Revenue Service (IRS)will not tax any compensation obtained from personal injury claims. In fact, the IRS does not consider this money as income at all. Because these settlements are designed to compensate you for losses, they are not “extra” but are instead intended to make you whole after your incident. The final decision typically depends on whether or not the settlement resulted from “observable bodily harm.” If bodily injuries were serious enough to result in a financial settlement, the federal government will generally not tax it.
This compensation extends beyond medical expenses and bills. An injured party would have been taxed on their income when it was originally earned and used to pay medical bills or insurance. The individual is not taxed again on any monetary reward meant to make up for lost wages.
Tax law also does not differentiate between installments or lump sum payments. There is no tax benefit to agreeing to the full up-front settlement versus accepting smaller installment payments in the coming months or years. Because there is no tax benefit one way or the other, you are free to make the best decision for your lifestyle, without worrying about giving up too much in taxes.
Taxable Personal Injury Settlements
Unfortunately, there are some forms of a personal injury settlement that could result in a tax liability. However, this class of damages is typically rare and makes up a small portion of a personal settlement agreement. These include:
- Interest accumulated on the settlement is considered taxable. This may include interest that accumulates after achieving a judgment, or the interest that may be set on delayed lost wages compensation.
- Some types of emotional distress compensation are taxable. The vital caveat is that this rule only applies to emotional distress damages that do not result from physical injuries. For example, if you received an emotional distress settlement because of a broken back, it is not taxable. If you received an emotional distress settlement based on a broken contract, it may be taxable by law.
- Medical expenses are not subject to taxation. However, you cannot benefit from compensation twice. For instance, you can deduct out-of-pocket medical expenses related to your accident from your income taxes if your case has not yet concluded. But if you are eventually reimbursed for those expenses, you must report it as income.
- Punitive damages are always considered taxable. Unlike most forms of compensation, punitive damages are not designed to “make you financially whole”. Instead, they are intended to punish a defendant for extreme behavior. Punitive damages are not typically not relevant in a personal injury lawsuit.
Speak to a Personal Injury Attorney
It is essential to consider the potential tax consequences of a settlement before agreeing to anything. If an offered settlement ultimately leaves you with a significant tax liability, it might not be the deal you had hoped for.
Tax implications are just one of the reasons you should hire a qualified personal injury attorney to help with your case. Be sure you are protected and getting the compensation you deserve – call Probinsky & Cole today.
