Do I Have To Pay Taxes On A Personal Injury Settlement?

When tax season arrives, you may want to consider mentioning your settlement money in your tax report. This is based entirely on the type of settlement you received and also why you were compensated. In general, personal injury settlements are not taxed for various reasons. If you are unsure about whether your personal injury falls within the tax-exempt category, an attorney will advise you on how this works. Here are some things to consider when you are filing taxes.

Settlement Money And Damages Are Considered Income

In general, any settlement money you receive for damages is considered income. When you file a lawsuit and receive an award as a lump sum. The IRS will most likely tax this form of income. However, personal injury settlements are treated differently. Settlement money that can be taxed can be for contract breaches, securities fraud, scandals, discrimination, and other forms of injustice. 

Personal Injury Settlements Are An Exception

A personal injury settlement is typically excluded from taxation. This is mainly because you suffered from a terrible injury that resulted in you requiring medical treatment. You may also be struggling with pain and suffering caused by another’s negligence. Because your injuries aren’t your fault or the damages associated with them, the IRS has no authority to tax your personal injury settlement. Even though these settlements can be considered a substantial way to finance yourself and your lifestyle, these remain in the tax-exempt status.

Settlements Excluded From Gross Income

You may be receiving your personal injury settlement over a period of time in several payments or in the form of a lump sum. Regardless, you can exclude your personal injury settlement from your gross income. You can then calculate your gross income and have this amount taxed separately from your settlement award. Additionally, you may have received lost wages for both the past and future amount of time that you were unable to work. Despite this fact, you can still exclude your lost income from taxation, according to Rev. Rul. 85-97

This settlement amount includes any damages received from emotional distress as well, even though these are not physical injuries. These are still considered personal injuries because pain and suffering can also have a severe impact on your personal wellbeing. 

Physical sickness is also considered a personal injury though it technically doesn’t stem from an accident, such as falling. If your settlement was the result of a physical illness that is somehow tied to another’s negligence, for example, medical malpractice, this amount will also be exempt. 

Punitive Damages Are Taxable

Even though you receive a personal injury settlement that is not taxable, your punitive damages will be treated differently. When you receive punitive damages, you should report this as other income in the Form 1040 online 8z. This is even if you received your punitive damages because of injuries you received due to your personal injury. The punitive damages are typically rewarded by the court because someone was grossly negligent or even malicious towards you. Even so, punitive damages are considered to be a part of gross income. 

In the case of wrongful death, punitive damages are not taxable. Wrongful death damages are the one exception that allows you and other surviving family members to receive punitive damages without having to report this lump sum as gross income. 

What If I’m Confused About My Type Of Settlement And Its Taxation Status?

Taxes can be confusing and require thorough research and sometimes a tax accountant to help you understand how you should report lump sum amounts and what you can deduct for. You can find out information on the IRS website to help you reveal what you can report regarding the settlement amounts you receive. Also, by contacting a lawyer and requesting their help, they will clarify for you whether or not your settlement is taxable.

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