After a personal injury case is settled, you may ask yourself: What happens next? In some cases, people will receive their compensation quickly, aside from the contingency fee that they owe to an attorney. In other cases, tax issues may pop up regarding the personal injury settlement.
Is compensation for physical injury taxable?
As a general rule, it is instilled that compensation received from most personal injury claims are not taxable under either federal or state law. The federal government (IRS) or the state can’t tax you on the settlement for the claims for anything – not for settling before filing a lawsuit in court, and even not for going to trial and winning a verdict. Federal tax law actually excludes damages received as a result of personal physical injuries or physical sickness from a taxpayer’s gross income. As a result, typical injury damages that are meant to compensate the claimant for certain things are not taxable as long as they come from a personal injury or a physical sickness.
There are exceptions, however. You could still be taxed on damages relating to a breach of contract if it is the breach of contract that causes your injury, and the breach of contract just so happens to be the basis of your lawsuit. To go along with this, it is good to understand that punitive damages are always taxable. If there are punitive damages involved with your claim, the lawyer will always ask the judge to separate the verdict into compensatory damages and punitive damages so that you can prove to the IRS that part of the verdict was for compensatory damages, which aren’t taxable.
Another thing to consider is: Does your case involve a claim of emotional injury? One must remember that the settlement or verdict is non-taxable only as long as it arose from a physical injury. This means that, if you have a claim for emotional distress or employment discrimination but no physical injury at all, your settlement would be taxable. This is, of course, as long as you don’t have to prove in the slightest that you also sustained a physical injury.
Why does the IRS end up taxing some expenses?
In some cases, people waiting for a pending claim could end up paying for medical expenses out of pocket. Many of these same people will then take the associated tax deduction. When these people settled their claim, the settlement included reimbursement from the insurance company for those medical costs. This calculated amount is considered income since it’s not money to reimburse you for your injuries or pain and suffering. The funds are, instead, reimbursement for the money you paid to the medical providers. Of course, things will vary from state to state as it depends greatly on the state’s income tax requirements.
Personal injury claims can end up being very complex and so you would want to enlist in an attorney to guide you in the right direction. Call WTW today to schedule a consultation and talk about your case in-depth. They will help you break down your settlement and figure out what you can expect in the realm of the compensation you rightfully deserve!