Most personal injury settlements are indeed non-taxable. However, in certain instances, the IRS can tax the settlement that you receive. If you’re planning to pursue (or currently pursuing) a personal injury case, it’s helpful to know the instances in which you might be required to pay taxes. If you’re unsure about your claim’s status, a consultation with a tax attorney will help you better understand your settlement’s taxability.
Non Taxable Settlements
The general rule is that settlements received from personal injury cases aren’t taxable. The important determining factor is the basis for your claim. If your claim is based on personal physical injuries or physical sickness, then it follows that any settlement you receive will be non-taxable. Personal injury cases may be settled even before they reach court; amounts received from these proceedings are also covered by the non-taxability rule, provided that they satisfy the requirement of personal physical injuries or physical sickness.
Taxable Settlements
The rule, however, has several exceptions.
- When the settlement is not based on physical injuries or physical sickness. An example of a case that does not involve physical injury or physical sickness is when the case is purely for emotional damages.
- When punitive damages are awarded. Punitive damages are awarded in tort cases to discourage behavior that is grossly negligent or unintentional. Punitive damages are taxable, even if the rest of the settlement isn’t.
- Interest on a settlement is taxable, even if the sum awarded is not taxable. Interest on physical injury settlements, for example, are taxable. Interest is usually paid when the defendant takes a long time in paying the settlement.
- Medical expenses that were already claimed as a tax deduction. Suppose you’ve claimed medical expenses as a deduction on your previous tax returns and were reimbursed for those expenses in the settlement. In that case, you have to declare the medical expense portion of your settlement as income.