Unfortunately, you were seriously injured because of the recklessness and/or negligence of a person or entity. While we know that no amount of money has made what you’ve suffered a positive experience, at least one good thing came out of it—you received a financial settlement to cover your medical expenses, rehabilitation, lost wages (and pain and suffering if applicable).
Are Personal Injury Settlements Taxable?
However, because you were compensated for your injury, you may now wonder whether the money you received is considered taxable income by the Internal Revenue Service (IRS).
In most cases, any money you acquired because of a successful personal injury settlement cannot be taxed. Generally, this means that the IRS doesn’t take anything from the monetary personal injury damages you were awarded for medical bills, lost income and non-economic damages like pain and suffering. Federal tax law excludes damages received because of injuries or illnesses from a taxpayer’s gross income.
However, there are many IRS loopholes, exceptions and exclusions that could make a part of your settlement or jury award taxable.
How The IRS Decides if Your Personal Injury Settlement is Taxable?
Depending upon the complexity of your personal injury case, it’s challenging to know is your personal injury settlement taxable? What the IRS taxes on personal injury settlements is based on the United States’ and Louisiana’s definitions of earned income. When the injuring party paid you (the injured person) for expenses related to your medical care, emotional distress and lost wages, the IRS considers this form of financial restitution to fall under compensatory damages, not income. Therefore, the amount of compensatory recovery you were awarded will not be taxed.
What Defines Compensatory Damages in a Personal Injury Case for Taxes?
To understand this facet of personal injury, it’s helpful to know the legal definition of compensatory damages. When a person is injured because of another’s recklessness and/or negligence and succeeds in winning an insurance claim or civil court lawsuit, they are reimbursed or compensated for their expenses, costs and suffering related to the specific physical and emotional harm they’ve endured. When a loved one (who meets certain criteria) died because of a person or entities’ conduct, compensatory damages also may be awarded to family members in wrongful death claims. In that case, wrongful death compensation is also non-taxable.
On the other hand, if a court orders a defendant to pay for your pain and suffering, because pain and suffering compensation is not considered compensatory, you’ll have to pay taxes on that amount.
Are Pain and Suffering Damages Taxable?
Because punitive damages paid to the injured person are intended to punish the defendant for their reckless and/or negligent conduct, such monies are not considered compensatory, whereas those for medical expenses, rehabilitation, and lost wages are.
The IRS looks at monetary recovery for pain and suffering much differently than for compensatory damages. When a judge orders a defendant to pay pain and suffering damages—which is extremely rare and occurs only when their conduct was extraordinarily egregious— this recovery is considered non-compensatory and will be taxed as income. Under IRS laws, money paid for pain and suffering is identified on your tax return as “other income.”
Personal Injury Settlement Taxes: Plans Matter
If you won a substantial, high-value financial recovery for your injuries or the loss of a loved one and invested that money in stocks, bonds, mutual funds, exchange traded funds (EFTs), money market accounts or real estate and you were paid interest, dividends or capital gains, interest, dividends or capital gains earnings are taxable.
While it’s better than not making money on your principal dollar amount, the IRS wants its cut of your investment or bank account earnings known as “interest income” or “capital gains.”
If you’re injured in an accident, you shouldn’t have to worry about taxes, and at Gordon & Gordon Law, we’ll provide the legal representation you need and guidance on what your settlement may be subjected to when filing a tax return.
Contact Gordon and Gordon for Personal Injury Settlement Tax Questions
For expert, caring and respectful personal injury assistance in one of our Shreveport, Mansfield, or Bossier City offices, call 318-716-HELP (318-716-4357). Or if you prefer, send us a message on our website and someone from our office will be in touch with you promptly.