Receiving a personal injury settlement can provide much-needed financial relief after an accident or injury. However, many people are unsure about the tax implications of such a settlement. A lawyer, like a tax lawyer, knows that in some cases, the money you receive from a personal injury claim could be taxable, but in others, it may not. Knowing when to report a settlement on your taxes is crucial, and working with an experienced tax professional can help you make the right decisions.
Personal Injury Settlements Are Often Not Taxable
The general rule is that compensation for physical injuries and pain treatment is not taxable. This means that if you receive a settlement for medical expenses, pain and suffering, or emotional distress related to your injury, you generally won’t have to report the money as income on your tax return. This non-taxable treatment applies to both lump-sum settlements and structured settlements.
However, there are exceptions to this rule, and these exceptions are what can make the situation more complicated. For example, if your settlement includes compensation for lost wages, it may be taxable. Similarly, certain portions of your settlement, such as punitive damages, could be subject to tax. A tax lawyer can help you figure out which parts of your settlement need to be reported to the IRS.
When Compensation For Lost Wages Is Taxable
If your personal injury settlement includes compensation for lost wages or lost earning capacity, that amount is generally taxable. The IRS views lost wages as income replacement, so it is treated as taxable income. This could apply if your settlement includes reimbursement for income you missed out on because of your injury or accident.
The taxability of lost wages may depend on how they are classified in the settlement. If the settlement specifically states that the amount is for lost wages, you can expect it to be subject to income tax. A tax lawyer can help you understand how to report this income and any deductions you might be able to claim to offset the taxable amount.
Punitive Damages Are Typically Taxable
Punitive damages are awarded in some personal injury cases as a way to punish the defendant for egregious behavior, rather than compensating you for actual losses. These damages are almost always taxable, regardless of whether the injury was physical or emotional. If your settlement includes punitive damages, you will likely need to report them as income when you file your taxes.
It’s important to note that while punitive damages are taxable, the other components of your settlement related to physical injury or illness may still be non-taxable. A tax lawyer can help you separate taxable from non-taxable amounts in your settlement, making it easier to determine what needs to be reported.
Emotional Distress And Other Non-Physical Injuries
Another area where the tax rules can get tricky is when the settlement involves emotional distress or mental anguish. If the emotional distress is linked to a physical injury, the settlement amount may not be taxable. However, if the emotional distress is not directly related to a physical injury, then the settlement could be considered taxable.
This situation is particularly relevant in cases involving defamation, discrimination, or other types of non-physical injuries. In these cases, a portion of the settlement that compensates for emotional distress may be subject to tax.
Working With A Tax Professional
Because tax laws related to personal injury settlements can vary based on the details of the case, it’s important to work with a tax lawyer or accountant who is familiar with these issues. A professional can help you understand the full scope of your settlement and determine what you are required to report on your tax return.
Attorneys like those at Crepeau Mourges can help you assess your settlement and work with tax professionals to ensure that you comply with all necessary reporting requirements. They can also help you identify any potential deductions or credits that could reduce your tax liability related to the settlement. For help, reach out to a law firm you can rely on today.