A personal injury lawsuit can be a long journey. Starting with an injury that may be painful, life altering and debilitating, it continues with an investigation, lawsuit, discovery, and in some instances, trial. Reaching a settlement brings a great deal of relief. The plaintiff has avoided the stresses of trial, and the defendant pays to make things right.
With check in hand, many plaintiffs ask a crucial question for the first time: Will the federal government tax my personal injury settlement?
The answer to this question depends on what kind of settlement you have. The basic rule is that payments for physical illness or injury are not taxable. These payments are designed to give you back something that you lost from your own body—your health and well-being. The government does not tax you for this because it is not really a net gain; it is just substituting the settlement money for the health that you lost.
Other types of settlement payments, however, may be taxable. Punitive damages punish the defendant for wrong conduct, but they do not compensate you for something you have lost. Interest payments and payments for emotional distress above and beyond medical treatment costs are also considered a gain to the plaintiff. In these cases, the IRS sees these payments as a windfall for the plaintiff, and may consider them taxable.
Payments for lost wages or lost profits are intended to reimburse you for money that you should have earned. Had you earned it originally, you would have paid taxes, so you may have to pay taxes on these types of settlement payments as well.
It is often difficult to apply these principles to the details of a particular settlement. We work with our clients and their tax professionals in the negotiation of personal injury settlements in order to best protect the value of the settlement and represent our clients’ interests.
If you have any questions about tax issues related to your personal injury settlement, contact us for more information.