At Hardison & Cochran, our personal injury lawyers commonly hear questions from clients along the lines of “Do you have to pay taxes on personal injury settlements?” or “Are settlements taxable?”
The answer is yes, portions of personal injury settlements or awards are taxed, but most of the damages recovered in a claim typically are not taxed.
Federal Tax Code Addresses Compensation for Injuries or Sickness
The federal tax code addresses compensation received due to injury or illness in Section 1, Article 104. It sets out rules for compensation received as workers’ compensation benefits and as damages received for personal physical injuries or physical sickness.
In short, you do not pay taxes on damages received for:
- Medical expenses
- Emotional distress
This applies to damages paid through prosecution of a personal injury lawsuit or a settlement agreement and whether you receive a lump sum or periodic payments.
Compensation for medical expenses or emotional distress recovered through a legal claim is not considered part of the taxpayer’s gross income for the year and is excluded from tax calculations.
We should note here that damages for medical expenses and for pain and suffering – including emotional distress – are usually the greatest portion of a personal injury settlement or judgment.
When Personal Injury Settlements Are Taxed?
As you might expect, money recovered in a lawsuit for lost income is taxed as income.
Article 104 of the tax code states specifically that punitive damages are not excluded from gross income and therefore are subject to taxation. Punitive damages, which may be assessed by a jury to punish a defendant for egregiously wrongful acts and to deter the defendant and others from committing similar wrongful acts, are not common awards.
Depending on the timing of your lawsuit settlement or award, you could incur taxes on damages for medical expenses if you had already deducted the cost of the medical bills in a previous tax year.
If you’ve already deducted your medical costs as a loss, then any compensation you receive for those payments will be taxed as income.
But if your medical costs were spread over more than one calendar year, only a portion would have been claimed in the prior tax year, so not all of your compensation for medical expenses would be taxable.
Further, some settlement agreements can be written to exclude additional damages from taxable income, and the IRS typically will not dispute the intent of the parties to the agreement.
Our advice is that you consult with a tax professional to determine your tax liability upon receiving a settlement or jury award derived from a personal injury lawsuit.
Contact Our NC Attorneys to Find Out How We Can Help
If you have been injured in a car accident or a fall or have suffered another personal injury caused by someone else’s negligence, contact Hardison & Cochran for help recovering compensation. A successful claim can keep you from suffering financially when others are at fault.
Call Hardison & Cochran toll-free at (800) 434-8399 today or fill out our online contact form for a free discussion of how we can help you.
