If you are involved in an accident that results in a personal injury settlement, you may have to pay taxes on your award.
How much you’ll pay largely depends on the type of award you receive, as well as how the settlement classifies your damages.
In this article, we’ll go over which portions of a personal injury settlement are taxable.
We’ll also discuss steps you can take to reduce the tax burden of your personal injury settlement.
Are Personal Injury Settlements Taxable?
Personal injury settlements are comprised of several different awards for various harms caused by an accident.
After a car accident, for example, an insurance company might offer you a settlement that includes $10,000 to cover your medical bills, $5,000 to repair your car, and $1,000 to cover lost wages.
The IRS will then consider each of these awards separately for tax purposes.
Notably, under current U.S. tax law, damages awarded due to physical injuries are non-taxable.
However, almost everything else is fair game as far as taxes are concerned.
For this reason, all of the following sources count as income for tax purposes, and are therefore taxable:
- Any damages that were not awarded due to physical injuries, such as costs related to repairing your car.
- Punitive damages.
- Lost wages or profits (which should be listed as “wages” and “business income,” respectively).
- Any interest gained from the settlement.
You will also have to return, in full, any tax deductions for medical expenses that the settlement itself compensated for.
For example, if you had surgery on your leg after a traffic accident, you may be able to write off that surgery on your taxes for that year.
However, if you receive a personal injury settlement in the following year to pay for that surgery, you might have to pay back the money that you previously wrote off.
Why are personal property damages taxable?
The 2018 Trump tax law has lead to a number of changes in how the IRS taxes personal injury settlements.
The biggest change is that the IRS can now collect taxes on damages awarded due to non-physical harms, which were previously not viewed as income.
For example, if you experience insomnia or headaches due to emotional distress caused by an accident, an award for those damages may or may not be taxable depending on whether your settlement categorizes them as “physical” or “non-physical.”
However, this is a complicated distinction that varies from case to case.
For example, if you are awarded damages due to emotional distress caused by physical harm, those damages may be taxable.
However, if the damages were awarded for the physical harm alone, you wouldn’t have to pay taxes on them.
Because of how this new law works, presenting a clear, concise argument in court is more important than ever.
For this reason, you should always talk about the exact phrasing of your argument with your lawyer before heading to court.
Further, you should make sure to ask about the possible tax consequences of your settlement before making any final decisions in your case.
How Can I Reduce My Tax Burden?
Under the current U.S. tax laws, there are a few things you can do to reduce the tax burden of your personal injury settlement.
For example, it is usually in your best interests to emphasize the physical nature of your damages to the court rather than emotional or punitive damages.
However, the best thing you can do to reduce your tax burden is still working closely with an experienced Virginia personal injury lawyer.
Since personal injury cases are so fact-specific, only an attorney can properly advise you on the best course to take in your case.