Do you have to pay taxes on a settlement? Personal injury settlements are not usually taxable, though there are some exceptions. See why punitive damages and other special cases are not tax exempt.
Are settlements taxable?
In most cases your personal injury compensation won’t be considered when filing for taxes. Federal tax law excludes most personal injury compensations from a taxpayer’s gross income.
However, this is not the case every time. If you’re wondering whether your car accident settlement is taxable, read through to the end of this post. If you still have questions, ask for free legal assistance from McMinn Law Firm.
What happens after you agree to settle a case? Understand the ins and outs of how a case works with guides by McMinn Law Firm.
Still have questions? The injury attorneys at McMinn Law Firm are available to answer questions, even after you are a client.
How to Know if Your Austin Personal Injury Lawsuit Settlement is Taxable
In this post, we’ll explain what is taxable in a personal injury or car accident settlement.
Good news: most lawsuit settlements are not taxable. When you settle with an insurance company, the amount you and your lawyer agreed upon will not be taxable. You’ll receive and keep the full amount of the settlement minus the lawyer fees for representation, leins against you (for example, child support in arrears),” and loans or other specific expenses as you and your lawyer have agreed to. It doesn’t matter whether you settled the case in mediation or after going all the way to court.
This is because the federal tax law, (administered by the IRS) states that damages received as compensation for Austin personal injury claims or physical sickness are not taxable.
Your claims are not taxable under state law in Texas either. In fact, they’re not taxable in any state. Let’s walk through what happens after a case with an example.
Infographic: What Does it Cost to Hire a Personal Injury Lawyer
In most cases – nothing! There are no upfront fees when signing on with a personal injury attorney. The law firm you choose to handle your case will not be paid unless you are. Contingency fees make hiring a personal injury attorney easy and affordable for any budget.
Example Shows Potential Settlement from Personal Injury
Say a person is severely injured in a trucking accident. They hire a lawyer who files a suit against the company. The injured person will receive compensation based on their medical expenses, lost income, and general damages. That person will receive a settlement (minus attorney’s fees) that is not taxable by federal or state government. Note that this situation includes compensation for physical injuries. If your claim for compensation is purely based on what are called “general damages” or “punitive damages” you may have to pay taxes on your compensation.
A Forbes article by writer Robert W. Wood explains how new changes in the Trump Tax law can affect those who receive personal injury settlements. You can read about how some plaintiffs may owe more than expected this tax season.
A Great Lawyer Understands How Taxes Can Affect Your Case
A great lawyer will fight to protect your interests every step of the way. Hiring a lawyer gives you an experienced advocate on your side. They can negotiate a settlement for your injuries.
If you have questions about how your personal injury case could affect your taxes, contact the legal team at McMinn Law Firm.
Is your claim exempt from taxes? Personal injury claims in Austin are not exempt from taxation every time.
Some exceptions to the tax exemption include:
- Punitive damages
- Emotional distress or mental anguish
Are Punitive settlements taxable?
This is one area where Uncle Sam will be able to reach into your claim amount. Punitive damages are always taxable. In the event you have a punitive damages claim, it will be designated by the jury how much of the claims are considered “compensatory” and how much are considered “punitive” damages.
Understanding Punitive Damages
What are punitive damages? Punitive damages are used to serve as punishment for grossly negligent behavior. The compensation will be awarded to the personal injury victim who suffered damages. They can be economic reimbursement for medical bills and lost wages or for pain and suffering claims. Punitive damages are a way to send a message that negligent or destructive practices aren’t tolerated in a community.
Rules around punitive damages: In Texas, they can’t exceed more than two times the amount of economic damages, plus the amount equal to non-economic damages. These are sometimes called “damage caps.” Read more about damage cap limits on personal injury settlements.
A good lawyer will ask the judge to specifically designate how much of the settlement is compensatory and how much is punitive.
Here’s why: Punitive damages are an exception to the general rule. (Remember that compensatory damages for personal injuries are, as a general rule, not taxable.)
It’s good for your tax purposes if the compensation for damages aren’t taxable, right? If you aren’t sure, ask your lawyer how much of your settlement will be considered “punitive damages” when the case is settled. In most cases, it may make most sense to secure a maximum amount in “special damages.”
How to report punitive damages
On your tax form be sure to report to the IRS the value of the punitive damages. According to the IRS, they should be reported as “Other Income” on line 21 of Form 1040. Even though the money may be collected from a personal injury settlement, it is still taxable.
Are your emotional stress or mental anguish damages taxable?
In most cases, the compensation from emotional distress damages will not be taxed. However, this rule may have changed under the new Trump tax reform. This could affect those who receive a settlement for wrongful death. In the past, the proceeds received under most circumstances will be treated the same as physical injury compensations (on special damages.) This should still be the case.
There are a few circumstances in which mental anguish proceeds must be reported as “other income.” This can happen if the proceeds from emotional distress do not originate from a personal physical injury.
Other considerations to make when filing taxes after settling a personal injury case:
Still not sure whether you owe taxes on your personal injury settlement? Check out these tips about paying taxes on lawsuit settlements.
- Interest: Amount earned as interest any any settlement income is still considered “Interest income.” Most states have rules that put interest on the settlement for the amount of time the case has been pending.
- Updates to your Health Insurance Marketplace: Don’t forget to let the Marketplace know if you have an increase in your income due to punitive damages.
- Loss-in-value of property: Generally property settlements for loss in value of property are not taxable if they are less than the adjusted basis of your property. If they are more, the excess is taxable.
- Lost wages or lost profits: You may have found this page while looking for tax information about an employment-related settlement. If you were compensated on the basis of involuntary termination or unlawful discrimination, you will most likely have to pay taxes on your settlement. The settlement is not considered personal injury.
Real life example: Governor Greg Abbott’s personal injury case
Do you know the story of why Texas’ current governor, Greg Abbott, is in a wheel chair? Here we will use it as an example to show how a serious injury can play a large role in a person’s life for many years to come. But one area that injury won’t play a large role – taxes.
In July of 1984 Abbott was out running with a friend in the Texas country. Suddenly there was a loud sound and Abbott was pinned to a tree. He never walked again.
The Texas Tribune released an article about the sum that Greg Abbott continues to receive as a structured settlement.
In his first settlement, Abbott received $300,000 in 1986. Thirty years after the accident, Abbott still receives $14,4000 per month. None of this income is taxable by the IRS. Abbott’s settlement is not taxable because his damages are for compensatory damages economic damages.
People who have been wrongfully injured are given the ability to seek compensation that will help them to live the way they did before the crash. Personal injury settlements are meant to compensate a person for things like wages, medical bills, emotional distress, loss of consortium, and attorneys fees. Personal injury damages are not taxed because it is not the intention of the area of the law to allow people to profit from an injury.
Still have questions about whether or not your settlement is taxable? Talk to a CPA or tax attorney about the specifics of your agreement.