Are personal injury claims taxable?
The Internal Revenue Service (IRS) will collect taxes on any earned wage or salary. The question then becomes whether the IRS taxes compensation from a personal injury like a wage or salary. The answer is it depends on the type of compensation you receive.
The general rule.
Generally, the IRS generally does not tax compensation from a personal injury case. Therefore, if you receive compensation for physical injuries and/or physical sickness, you will not be subject to tax. Whether you suffer a personal injury and receive compensation for things like medical bills, emotional distress, pain and suffering, and loss of consortium, you will not be subject to tax as long as the claim arises from a physical injury or a physical sickness.
You may wonder what classifies as a physical sickness. For example, exposure to mold in your apartment can qualify if you get sick. In that case, any recovery you obtain due to that illness would not be taxable.
Exceptions to general rule.
When a jury provides a judgment, the court will tack on interest for the Plaintiff. For example, say you suffered an injury in 2018 and filed a lawsuit that year. You litigate the case for 2 years before reaching trial. At trial, the jury renders a judgment of $100,000.00 for personal injuries. The court will add interest to the judgment starting from the date you filed the case. In this example, using a 10% interest rate, you would get an additional $20,000 in interest ($100,000 x 10% x 2 years). Therefore, the full judgment would be $120,000.00 in this scenario. In sum, you would not pay taxes on the $100,000, but would have to pay taxes on the $20,000 of interest.
Emotional Distress or Mental Anguish
If you remember from above, only judgments for physical injuries or physical illnesses are non-taxable. Therefore, if your claim is for emotional distress or mental anguish without a physical injury or illness, any compensation you receive would be completely taxable.
Punitive damages are not meant to compensate you for the harm done, but to punish the conduct society wants to deter. For example, Company X is dumping toxic waste into the local water supply, and members of the community suffer injuries. An injury victim sues Company X. At trial, the jury renders a judgment of $1,000,000 to the Plaintiff for physical injuries and/or illness, and then provides $2,000,000 in punitive damages to punish Company X and deter future toxic waste dumps. The $1,000,000 would be non-taxable, while the $2,000,000 would be completely taxable.
Lost income is an item recoverable in an injury claim. If you did not earn income due to an injury, you can recover the amount lost. However, since you would have paid taxes on the income if you were healthy and had earned income, you have to pay taxes on any amount of the settlement or judgment that amounts to reimbursing you for lost income. Therefore, you must report a settlement or judgment for lost income on a tax return.
Medical Expense Deductions
A taxpayer can deduct expenses associated with medical care. If you suffered an accident, for example, in 2019, and incurred expenses for medical care, you can deduct the value of the expenses from your 2019 taxes. Now, say you receive a settlement in 2020 that includes reimbursement for the same medical expenses you deducted in 2019, the IRS will tax the portion of your settlement that went to reimburse you for these expenses.
Breach of Contract
If your primary claim arises from a breach of contract, even though you also suffered a physical injury or illness, any compensation received from the claim will be 100% taxable.
It’s not about how much you make, but about how much you get to keep. It is essential to know whether your settlement or judgment will be subject to taxes. Taxes will affect the amount of compensation you can expect. Perhaps more importantly, you want to avoid penalties on unreported taxable income.
You need an experienced personal injury lawyer at JSM Injury Firm APC to review the circumstances of your claim to assess whether any portion of your recovery will be taxable, so that you can work to maximize the non-taxable parts of your claim. Schedule a free consultation by clicking here.