Will I Pay Tax on My Personal Injury Settlement?

Will I Pay Tax on My Personal Injury Settlement?

Once you come to a successful settlement agreement with the defendant or his/her attorney, you might assume the amount of the offer is what you will get to keep. Unfortunately, this is not the case. Court costs, attorney’s fees, and unpaid bills will all come out of your settlement award. Then you might face further deductions once tax season comes along. In most cases, however, your personal injury settlement is not subject to taxation in the state of Georgia. Here’s how the Internal Revenue Service (IRS) will handle settlement taxes.

Taxable, Untaxable, or Partially Taxable?

The circumstances of the personal injury claim and type of injuries suffered will determine whether the IRS taxes or does not tax settlement awards. In the vast majority of cases, your civil claim settlement will not qualify as taxable earnings in the United States. This is because the IRS does not consider the money received in a settlement “wages” or “salaries.” Instead, settlements are compensatory income.
A settlement will likely be nontaxable if it paid you for damages that directly correlate with a physical injury or illness. These include medical bills, physical pain and suffering, and emotional distress. Since the settlement reimbursed you for out-of-pocket costs, the IRS does not deem it as taxable income. Property damage repair settlements are also nontaxable and can include the costs of money spent on a rental vehicle. For the most part, compensable income is nontaxable. However, there are a few exceptions.
Many settlements will include both taxable and nontaxable award types. In these cases, the IRS will tax only part of your total award. Partially taxable awards might require you to prove the IRS that a portion of your settlement is nontaxable; otherwise, the IRS might try to tax the full settlement amount. Your attorney can help you understand which portion of your settlement is taxable and even arrange a separate settlement payment to make your conversations with the IRS easier.

Commonly Taxed Parts of Injury Settlements

The IRS will tax certain settlement awards or parts of settlements that have to do with the reimbursement of lost wages. This is because the IRS would have taxed these wages ordinarily had the injury not occurred. In other cases, your settlement might be taxable if you deducted your out-of-pocket injury costs on your last tax return. This is due to the desire to prevent “double dipping.” If you deducted your costs at the time of payment, the IRS might tax the settlement award to make up for the deductions you received.
Aside from lost wages and previously deducted expenses, other parts of a settlement that may be taxable are non-economic damages that do not directly relate to a physical injury or illness. For example, if your case involved employment law or wrongful termination, the IRS will likely tax your mental anguish and emotional distress settlement award. Punitive damages, or extra damages the courts award to punish the defendant, are also potentially taxable, even if they directly relate to a physical injury. Ask your attorney to have the courts separate your settlement award into punitive and compensatory damages to you can prove to the IRS which are taxable and untaxable.

How to Find Out if You Owe Taxes on a Settlement

Failure to pay taxes you owe on a settlement award can get you into serious trouble with the government and result in penalties such as wage garnishment. The best way to learn whether your recent personal injury settlement is taxable is to speak to your attorney. Settlement and judgment award taxation can be complicated, depending on the extent of your injuries, type of lost wages, and many other details. Your lawyer will be able to assess your individual case and help you understand how the IRS may or may not tax your compensation awards.