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How Are Personal Injury Settlements Taxed?

Personal Injury Settlements are Tax Exempt (Mostly)

The IRS considers most legal settlements taxable income. However, personal injury settlements are typically tax-exempt. This article will outline a few exceptions. Taxes on the settlement amount must be paid by the winning party.

As far as the IRS is concerned, personal injury settlements are compensatory. Compensatory damages do not count as taxable income. Note that this is true whether payments take the form of a structured settlement or lump-sum payments. There are some additional factors that inform the tax status of these payments:

Damages won for “pain and suffering” are not taxable. That is, they are not taxable when tied to a physical injury or illness. An experienced personal injury attorney will help their client make that connection whenever possible so that income remains tax-free. 

There may be punitive damages when the cause of injury is tied to willful, wanton, or reckless behavior. Punitive damages are a form of punishment. They are usually taxable. In some cases, punitive damages are not taxed. So, a knowledgeable attorney can help you understand what to expect from your case.

Examples of Non-Taxable Settlements

Compensatory damages:

  • Workplace or construction injuries (see a workers’ compensation attorney)
  • Harm done by medical malpractice, specifically tied to physical illness
  • Dog bites
  • Serious harm caused by defective medications
  • Injury caused by automobile accidents. (Settlements for property damage are taxable, however)
  • Cases of wrongful death

That final example is a distinct kind of personal injury lawsuit. In wrongful death cases, the court can order compensation for the family’s loss of income, loss of future inheritance, medical expenses, funeral expenses, and emotional distress. Any associated compensatory damages are completely tax-free, but any punitive damages are taxable as income.

Read more: (From the American Bar Association) “Taxes on Legal Settlements

In conclusion, this is good news for recipients of a personal injury settlement. Most kinds of personal injury settlements are not taxable. A qualified attorney can help you understand what to expect from your case. When the court demands to see a connection between your injury and the costs it has incurred, a personal injury attorney will know how to make that connection.

If you have questions about your own personal injury case, do not hesitate to contact us today. I offer free case evaluations and can help you understand your options.

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