Do You Have to Pay Taxes on a Settlement or Judgment?

They say there are two things guaranteed in life - death and taxes - but does this truism carry over to settlements and judgments stemming from personal injury claims? There is actually no clear-cut answer, as there are many factors that come into play regarding the nature of and circumstances surrounding your case.

We hope the information here will help you ask your tax advisor the right questions so you end up with the answers you need. Your goal when you consult an attorney should be to do just that. As tax laws are ever-changing, only a discussion with an expert in the field can provide you with the most up-to-date and relevant information. Although only your tax advisor is qualified to give you tax advice, there are still some rules of thumb that can give you a pretty good idea about what's taxable and what's not. Does the Tax Code Affect Your Settlement? The Internal Revenue Service (IRS) answers questions regarding the taxability of settlements and judgments in their section discussing "Compensation for injuries and sickness." It states that the damages received due to personal physical injuries or sickness is typically excluded from one's taxable gross income, except in cases in which punitive damages are awarded. Emotional distress does not fall into the category of a physical injury or physical sickness, and any compensation for it, therefore, is generally subject to being taxed. Any damages received not in excess of the amount paid for medical care is also excluded from one's taxable income. Compensation for Medical Expenses and Injuries Most settlements and judgments are for general damages and compensatory damages, both of which are intended to cover your medical expenses, lost wages, and pain and suffering resulting from your injuries. These types of settlements are mostly exempt from being taxed because they are solely intended to reimburse you for expenses that you've had to pay for out of your own pocket. Compensation for Vehicle and Property Damage Similar to the damages received for medical expenses and injuries, compensation received for vehicle or property damage is generally not taxable. Damages paid for vehicle and property damage include the cost of repairs, as well as any other related expenses, such as reimbursement for the rental car you paid to drive while your vehicle was unavailable. These expenses add up, so make a point of documenting each of them as they come up. Compensation for Lost Income In most cases, any settlement or judgment you receive to compensate you for lost income is subject to income tax. This makes sense because, if you had been able to earn your income, that income would have been taxable. Therefore, compensation replacing the income you would have earned is taxable, too. Settlements and judgments are often made up of many different parts, so if yours includes damages to cover medical bills and property damage as well as lost wages, you are still required to pay taxes on the portion meant to compensate for lost wages. Punitive Damages While punitive damages are hardly ever awarded in car accident settlements and judgments, it does happen from time to time. Punitive damages are generally awarded to punish the defendant for what they did and to discourage them from continuing their behavior. If punitive damages are a part of a settlement or judgment, it is generally because what the defendant did was especially egregious, and they lacked remorse for their actions. In cases where punitive damages are awarded, these damages are, as a rule, treated as taxable income. The Bottom Line Unless you hire a lawyer who is an expert in tax law to represent you in your personal injury case, which is generally not recommended, you should not expect them to provide you with in-depth tax advice. That being said, an experienced personal injury attorney should be able to provide some general information regarding the taxability of your settlement or judgment, but their main job is to get you the settlement you deserve for the injuries you suffered. If you have questions that require a greater level of tax expertise, find a tax professional to get the answers that you need.

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