Is a personal injury settlement taxable?

Once you finally receive your injury settlement, you can get started on piecing your life back together. However, the upcoming tax season might leave you concerned that Uncle Sam will take a percentage of your personal injury awards. 

Knowing what parts of your settlement are tax-exempt helps you maintain as much of your payout as possible.  

What is not taxed in an injury claim?

The IRS typically does not tax proceeds from a personal injury settlement. This stance is based on the condition that the proceeds were directly related to your personal injury. That means that the following should not be included as income:

#1 — Medical Bills

Any compensation you receive for your medical bills is tax-exempt. This also includes any ongoing medical treatment you will need in the future. The only exception is if you deducted medical expenses in previous years. In that case, you would take a portion of your settlement for medical costs and include that as taxable income. 

#2 — Property Damage

For those involved in a car accident, it’s important to note that the compensation you receive to repair your vehicle is tax-exempt. This includes paying for a rental car while your car is being repaired. 

#3 — Pain & Suffering Related to Your Injury

Any compensation for mental and emotional damage done as a direct result of your accident will be tax-exempt. New Link Destination
avoid taxes on your pain and suffering awards, you must have visible injuries like broken bones or bruises. 

Other Nontaxable Insurance Claims

Depending on the nature of your accident, you may be required to file different types of claims. 

Here are a couple of claims that are also tax-exempt.

Workers’ Compensation Claims

When injured workers collect workers’ compensation benefits due to an accident or injury, they won’t have to worry about taxes either. This principle also extends to any surviving family members if an employee dies. 

However, there is one exception to workers’ compensation claims. Suppose an employee receives both social security disability and workers’ compensation benefits. In that case, the amount received from social security disability will be taxed. 

Wrongful Death Claims

Surviving family members may pursue a wrongful death claim against the at-fault party when a loved one dies due to another’s negligent actions. Any compensation received in the final settlement is considered tax-exempt. 

Life Insurance Proceed

If you are the primary beneficiary on a life insurance policy, any proceeds you receive from the death of a loved one will be tax-exempt. The IRS states that any interest you receive on life insurance proceeds is taxable income. 

What is vulnerable to taxation in a settlement?

A lot goes into determining the total value of your injuries and losses. This can result in a substantial settlement depending on your case. Although the IRS doesn’t typically interfere with your personal injury awards, some taxable items include:

#1 — Punitive Damages

Punitive damages differ from your average compensatory damages like medical bills and pain and suffering. Punitive damages are awarded when the plaintiff proves that your injuries were caused by the defendant’s reckless disregard for the safety of others. These damages punish the at-fault party. Although they are rarely awarded, punitive damages will always be taxed. 

#2 — Lost Wages

In business law cases regarding unlawful termination and other instances, lost wages are usually taxed. However, your award for lost wages in a personal injury case may also be subject to taxation. This is based on the fact that if you had not been injured, you would have included your earned wages as income anyway.

#3 — Accrued Interest

Achieving an appropriate settlement amount for your damages can be a long process. During the duration of your case, you may accumulate a high amount of interest. Although the principal amount of your settlement is tax-exempt, the interest is not.

#4 — Emotional Only Claims

As stated above, pain and suffering resulting from an injury is tax-exempt. However, you must have visible injuries to receive nontaxable awards for your mental anguish. Any compensation you receive from emotional distress alone is taxable.

#5 — Attorney Fees

Any reimbursement you receive for your attorney fees in your final settlement will be considered taxable income. The exception is only for employment discrimination cases and whistleblower rewards where all attorney fees are tax-exempt. 

How much will my final settlement be taxed?

Unfortunately, there is no concrete answer to this question. The amount you will be taxed depends on many factors like your salary and how much of your settlement is considered taxable income. 

How to Maximize Your Injury Settlement

When pursuing personal injury compensation, the goal is obvious: fight to receive as much as you can. This involves knowing what battles to fight and what ones to avoid. Relentlessly pursuing a fair settlement for your medical bills may be more beneficial than punishing the at-fault party for taxable punitive damages. Understanding what parts of your claim will be taxed can help you be more strategic when negotiating a settlement. 

Case Studies: Taxability of Personal Injury Settlements

Case Study 1: Tax-Exempt Components 

Mr. Smith received a personal injury settlement from Insurance Company Alpha. The settlement included compensation for medical bills, pain and suffering, and property damage. The court determined that the portion of the settlement allocated to medical bills and property damage was tax-exempt.

However, the court ruled that the punitive damages awarded to Mr. Smith were subject to taxation. This case highlights the differentiation between tax-exempt and taxable components of a personal injury settlement.

Case Study 2: Taxable Components 

Mr. Johnson filed a personal injury claim against Insurance Company Beta and received a settlement that included compensation for lost wages and accrued interest. The court determined that the portion of the settlement allocated to lost wages was taxable, as it represented income that Mr. Johnson would have earned if not for the injury.

Additionally, the accrued interest on the settlement amount was also subject to taxation. This case demonstrates how certain components of a personal injury settlement can be vulnerable to taxation.

Case Study 3: Nontaxable Insurance Claims 

Ms. Anderson pursued a personal injury claim against Insurance Company Charlie and received a settlement that included compensation for medical bills, pain and suffering, and emotional distress. The court deemed the portion of the settlement allocated to medical bills and pain and suffering as tax-exempt.

However, the compensation received for emotional distress alone was considered taxable income. This case emphasizes the distinction between tax-exempt and taxable claims within a personal injury settlement.