Have you recently received a settlement in a personal injury case? You are probably wondering if your compensation is taxable. The answer depends on the specifics of your case, and how the compensation was issued.
What Parts of My Personal Injury Settlement Are Taxable?
The compensation you receive for a physical injury or physical sickness is typically not taxable by your state or the federal government. This applies to settlements achieved outside the courtroom or court-ordered settlements. Personal injury damage awards are not considered income under federal tax law if the damage is physical.
While personal injury settlement taxes generally do not apply to physical injury or physical sickness damages, there are certain exceptions in which your settlement funds, or a portion thereof, would be taxed:
- If a breach of contract caused your personal injury and is the basis of your legal claim, damages are taxable.
- Interest is sometimes awarded on your settlement due to the time in which your case was pending. Any interest you are awarded is taxable.
- Punitive damages may be awarded in your case in addition to compensatory damages. Punitive awards are taxable.
- Settlements relating to emotional injuries are taxable if they did not originate from a physical injury or sickness.
- Recoveries that are considered wage loss or profit loss are taxable. This is common if the injury or sickness was related to your employment.
If deducted medical expenses relating to your personal injury provided you with a federal tax benefit in any year, you must include the settlement portion for these deductions as income. It can be reported as “other income” on your 1040 tax form. If you paid these medical expenses over the course of more than one year, the proceeds will need to be allocated on a pro-rata, or proportional basis over all the years in which they were paid.
There are many complex and confusing rules governing lawsuit settlement taxes. If you have questions about personal injury settlement taxes or whether or not the settlement you have received may be considered taxable, contact Peterson & Associates. We will be happy to help you navigate the settlement process.