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Are Personal Injury Settlements A Taxable Item?

Posted in Our Blog on April 4, 2022

Let us be honest – filing taxes is a cumbersome process for the average person. Filling up countless boxes and blanks should be enough paperwork aggravation for the entire year. Suppose by no fault of your own, a car accident and injuries occur, bringing with it a landslide of even more confounding paperwork from medical bills to insurance companies to ultimately settlements. It can feel a bit unwieldy. 

Luckily, a good lawyer can help figure out the intentionally perplexing trappings and red tape concerning accidents and injuries. But how does it all affect taxes?

The general guidelines indicate that many portions of personal injury settlements are tax-free, but U.S. tax codes can be tricky, and in certain circumstances, a large amount of the damages received in a settlement can be seen as taxable income.

Just as finding the right attorney to negotiate a claim is needed, a visit to an accountant or tax preparer may be needed to get specific answers based on the details of a particular settlement.

What Types of Damages are Taxable?

The guidelines for determining taxable income are outlined by the Internal Revenue Service (IRS) in the Code of Federal Regulations. In short, if a settlement includes compensation for a taxable loss, the compensation is also taxable.

A few possible examples of non-taxable portions of a settlement include:

  • Property Damages: Compensation for these damages include the costs of replacing or repairing property that was broken or destroyed during an accident. Generally, this is not taxable compensation.
  • Medical Costs: In most situations, the expenses associated with medical care and treatment or any related costs accumulated after sustaining injuries are covered by the victim. Because these costs come out of pocket initially, the reimbursement for the costs are typically not taxable.
  • Pain and Suffering: Most compensation for these types of damages stem from physical injuries sustained in an accident. These elements of a settlement are usually unquantifiable under the tax codes, and hence, cannot be taxed.

Some aspects of a settlement that may be taxable include:

  • Lost Wages: Compensation for lost income is seen as just that—income. Normal wages factored into the damage award are regularly subject to taxation.
  • Medical Costs: Yes, this same item was listed above as non-taxable, but as the very nature of taxation can get complicated. But the reason it is listed as tax and tax-free is simple – if the expenses accrued due to medical care were written-off as a tax deduction in the previous year, they may be taxable after compensation is received.
  • Pain and Suffering: Here we go again, with this point also listed in the untaxed list. If someone is not physically hurt during an accident, but psychological and/or emotional distress are awarded in a settlement, this compensation may be taxed.

Okay, but What About Punitive Damages?

Compensation for punitive damages are more than simple settlements that are meant to compensate a victim for their losses. Punitive damages are meant to punish the defendant’s negligent behavior and/or intentional harmful or reckless actions.

Punitive damages can be awarded by a judge or jury, and they can be significant in cases concerning personal injury and/or wrongful death.

The IRS considers most punitive damages as taxable under federal tax laws. These damages have been known to throw taxpayers into higher tax brackets, but tax preparers and accountants can help find ways to avoid these types of issues.

When to Pay or Not to Pay, That is the Question

Every year, most American workers receive the Form W-2: Wage and Tax Statement, better known as just a W-2. This statement reports a worker’s income and the federal and state taxes paid for the previous year.

The year following a personal injury settlement, the insurance company or another entity that paid the settlement should send a 1099 Form to the compensation recipient and the IRS. This form reports the compensation paid for settlements and judgments, and whether the funds were taxable.

While filing taxes, this form should be included as income. Here is when the determination is made regarding additional taxes like Medicare and Social Security. An employer usually withholds these taxes, but when someone loses time at work due to an accident, damage settlements for lost wages do not automatically take out the taxes. This leaves the recipient of the damages responsible for that payment.

Taxes? Probably Not, but the Settlement or Verdict Needs to Happen First

Getting to the point of determining taxable compensation in a settlement is the conclusion of what can be a lengthy process. The beginning of this process starts with property damage and injuries. This is followed by the readjustment of lives, the recovery, the putting things back together again. This is where a skillful personal injury lawyer can help.

A good lawyer guides their clients through the complex maze of the insurance claim process. Litigating this process should be managed forcefully and strategically and may include:

  • Filing initial claims
  • Investigating the circumstances of the crash
  • Presenting evidence
  • Negotiating settlements 
  • Representing clients in front of a judge and jury at trials.

A personal injury lawyer should be accepting and approachable to clients, acting as an instructor, consulting, and advising with every step of a case, including:

  • The initial consultation 
  • Evidence gathering
  • The strength of the evidence and/or the strength of the case 
  • Options for recovering compensation
  • The range of damages and settlement options
  • Decisions concerning going to trial
  • Determining which damages will be taxable
  • Negotiating and structuring settlements to avoid excessive tax bills

Deadlines for filing personal injury claims can be different from state to state. According to the civil code, Louisiana has a one-year time restriction. Beginning a lawsuit can be daunting without a lawyer because of the various legal jargon and actions to complete just to get started. Hesitating is not a good option.

If you are in need of a personal injury attorney you can trust, contact the Law Office of John W. Redmann, L.L.C. by calling 1-504-500-5000 or clicking here for a free consultation of your case.