Unless an exception exists, the general rule is that the proceeds received from most personal injury cases are exempt from both federal and state taxes. It is irrelevant for tax purposes whether you received a settlement pre-filing or after filing a complaint or obtained a judgment at trial. Neither the state or federal government can tax your settlement or verdict. The Federal tax code excludes damages received as a result of personal physical injuries or physical sickness from a taxpayer’s gross income.
Therefore, personal injury damages intended to compensate the claimant for damages such as medical bills, lost wages, pain and suffering, emotional distress, loss of consortium, and attorney fees are not taxable as long as they come from a personal injury or a physical sickness.
The Exceptions to the General Rule
There are several important exception to the general rule when personal injury damages will be taxable including: punitive damages; emotional injury claims; terest; and lost wages in an employment case.
Unlike typical injuries intended to compensate the victim which are not subject to taxation, punitive damages are meant to punish the wrongdoer. An award of punitive damages is taxable and must be reported as “Other Income” on line 8z of Form 1040. Your personal injury lawyer will want to get an order from the court separating out the awards, in order to prove to the IRS that part of the verdict was compensatory, and thus, not taxable.
Emotional Injury Claims
As noted above, only injuries associated with a physical injury are non-taxable. Thus, suffering emotional distress without any physical injury is taxable. For example, you receive damages as a result of witnessing someone else’s injury. For this amount of the damages, you will have to pay taxes. However, the amount you must include is reduced by: (1) amounts paid for medical expenses attributable to emotional distress or mental anguish not previously deducted and (2) previously deducted medical expenses for such distress and anguish that did not provide a tax benefit.
Interest on any settlement is generally taxable as “Interest Income” and should be reported on line 2b of Form 1040.
Lost Wages in Employment Suit
You may have to pay federal taxes on any part of your settlement awarded for lost wages in an employment-related lawsuit because these are viewed as taxable wages.
Timothy L. Miles
Timothy L. Miles is a nationally recognized shareholder rights attorney raised in Nashville, Tennessee. Mr. Miles was recentely selected by Martindale-Hubbell® and ALM as a 2022 Top Ranked Lawyer, 2022 Top Rated Litigator. and a 2022 Elite Lawyer of the South. Mr. Miles also maintains the AV Preeminent Rating by Martindale-Hubbell®, their highest rating for both legal ability and ethics. Mr. Miles is a member of the prestigious Top 100 Civil Plaintiff Trial Lawyers: The National Trial Lawyers Association, a superb rated attorney by Avvo, a recipient of the Lifetime Achievement Award by Premier Lawyers of America (2019) and recognized as a Distinguished Lawyer, Recognizing Excellence in Securities Law, by Lawyers of Distinction (2019).
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