A common question accident victims have is whether they will need to pay taxes on a personal injury settlement. The rules for federal taxes are complicated, but we boil them down in this article so you can see what you might owe. Contact our personal injury attorneys to discuss any accident that has injured you.
You Owe No Taxes on Compensatory Damages for Personal Injuries
The good news is that most settlements will be exempt from taxes. That is because the IRS exempts from taxation compensatory damages based on physical injuries, and most personal injury cases involve bodily injuries sustained in a crash or other accident.
For example, if you suffered a broken arm, concussion, back injury, nerve damage, whiplash, or any similar bodily injury, your compensatory damages are tax-free. Compensatory damages include:
- Medical care and bills
- Lost income or wages
- Pain and suffering
You will not need to pay any taxes on these amounts. However, if you receive interest on your settlement, then that interest is taxable.
You Will Pay Taxes on Punitive Damages
The IRS will tax any punitive damages you get. Of course, Washington law does not recognize punitive damages, so these do not come into play in most cases. But you might have been injured in a state that does award punitive damages to punish a defendant.
As you can imagine, punitive damages are rare in personal injury settlements. Instead, in those states that allow them, punitive damages are usually awarded by juries if a case goes to trial but insurers resist paying them.
What About Settlements Not Based on Physical Injuries?
You will probably owe taxes if you get a settlement for something other than physical injuries.
For example, the IRS will tax compensation for emotional distress that is not based on a physical injury or illness. You might bring a claim for intentional infliction of emotional distress based on outrageous behavior by the defendant. If you receive compensation for emotional distress, then you will owe federal taxes.
Another example is a personal injury case based on defamation, which is an injury to your reputation caused by lies. Because this injury doesn’t include a physical injury or illness, any compensation you receive is taxable at the federal level.
You might also be paid money to keep a settlement confidential. If so, then this “hush money” is taxable. So if you were injured by a famous person who insisted on a non-disclosure agreement, then some of your settlement might be taxable.
Work with Our Personal Injury Attorney
A seasoned lawyer can help clients by clearly allocating compensation in an agreement. Imagine you settle an assault case for $150,000. If $50,000 is for punitive damages, then you want to clearly identify it as such. If you fail to, the IRS might claim the entire amount is for punitive damages, which would make the entire settlement taxable.