A huge number of personal injury cases get settled before it reaches the trial stage. As per stats released, only about 4 or 5 % of the cases reach the courtroom, the rest are resolved through settlement or providing compensation. Once the offer is accepted, your lawyer will send the defense attorney an acceptance email or letter. After this, you get your money but this personal injury settlement can be taxed under certain circumstances. Read below to learn more about it:
What are the Taxable settlement amounts?
The below proceeds are taxable:
Interest: The money received as interest in a personal injury settlement is usually taxable
Mental anguish and emotional distress: As mentioned above, the compensation that is received for mental anguish and emotional distress that is directly connected to the injury or sickness is not taxed. But in certain circumstances when there is no relation between the physical illness, injury and the emotional distress the settlement money is taxed. Non-physical injuries like harassment, discrimination, breach of privacy, wrongful termination, etc are taxable personal injury settlements. As these do not involve physical injuries.
Punitive damages: The monetary reward to the victim that goes beyond the compensation for injuries that are meant as an added punishment to the wrongdoer is called punitive damages. Here even if there are physical illnesses or injuries associated with it, the settlement amount is taxed.
Claims for emotional injury only: If you suffer no actual physical injury and make a claim for emotional distress then your verdict or settlement will be taxable. Only if there is a physical injury will the reward be non-taxable.
Is the Settlement Taxable?
If you have suffered some serious injuries in an automobile accident and you are counting on the settlement money to pay for medical costs and loss for income. It would be a nightmare if you had to pay taxes on them. But fortunately, in most scenarios accident victims need not pay taxes but it mainly depends on the claim made by the victim.
Usually, the proceeds from the verdict as well as the settlement are not taxable. Legal experts at Preszler Law Firm of Halifax say that most people don’t have to pay taxes on personal injury settlements, but there are some exceptions, so it’s wise to talk to a lawyer and hash it out. Section 104 of the tax code says that personal injury claims where physical injuries are involved, the proceeds are exempted from the state and federal tax. The tax department does not consider the money as income or salary and hence it is not taxed.
If you are worried that filing a lawsuit may lead to reduced payout due to taxes there is nothing to stress about. For taxation, it is irrelevant if the case goes to court and the verdict is given by the jury or is settled before it goes to court. The state does not have the authority to tax you on the proceeds of personal injury claims. The same applies even for Federal tax, it excludes the money received due to personal injuries from the gross income.
The settlement offered due to the following is excluded from taxation:
- Medical bills
- Lost wages
- Pain and suffering
- Attorney’s fees
- Emotional pain and distress
- Loss of consortium.
Exceptions to the General Taxation rule
Every rule has an exception! In the case of a personal injury settlement, you may be taxed for the proceeds of physical sickness or injury. That happens when there is a breach of contract and that causes injury. If the basis of the claim is a breach of contract then there will be taxations on the proceeds. Additionally, if you have made a claim for punitive damages it has to be a separate verdict. That way it can be proved to the IRS that it is part of the compensatory damages and thus becomes non-taxable.
If your case has been pending for a while, most states have rules that the interest is added to the proceeds for the period the case has been pending. For example, if you file a claim on Jan 1, 2020, then you will get an interest on the verdict until you get the payment. If the defendant files for an appeal, interest is added until the final verdict. But this amount is taxable.
Income loss compensation
If the injury you sustained during a car accident results in loss of income, the compensation is calculated on a ‘net’ income by the court and insurance companies. That means, they would calculate the amount of money as lost wages for the period after the accident and then cut the amount of taxes that you would have had to pay in case there was no injury and had earned income. This calculation is done based on the tax bracket you fall to. So when you receive compensation for income loss, you are already taxed appropriately. So there will be no more taxation on the settlement received for income loss.
How to ensure the settlement is non-taxable?
Most of the personal injury claims will have two different claims one that is related to the personal injury caused due to the vehicular accident and the other is non-physical injury. In such scenarios, it has to be clearly mentioned in the settlement agreement that one amount is for physical injury claim and the other for non-physical injury. The settlement amount is generally more for physical injuries and hence the draft has to be carefully done so as to prevent any confusion when dealing with the tax officials.
Another thing to consider is the cost of the attorney fees. If you are using the lawyer on a contingency basis, he/she gets one-third of your proceeds. But just for the purpose of the tax, you may be treated as getting the complete share even though you pay the attorney one-third of the amount.
If the personal injury settlement is only for physical injuries then no part of the proceeds is taxable. But if a part of it is for non-physical injuries, IRS will tax that money. Every rule be it tax-related or legal has exceptions, so to make the best use of it, seek professional help before accepting the claim. The attorney helps in negotiating for more and also helps with not getting taxed.