Are personal injury settlements taxable?

If you’ve been injured in an accident, you know how much your life can be changed in an instant. Hopefully, you have a competent attorney to represent you and get you the compensation that you deserve.  If you are fortunate enough to receive monetary compensation for your personal injury, you might be wondering whether you have to pay taxes on this new income.

As with any tax topic, the answer is a bit complicated. Whether or not your personal injury settlement is taxable will depend on a number of factors, including:

  • Whether you have deducted medical expenses the prior year;
  • Whether you receive a settlement for lost profits from your business;
  • What amounts you might be receiving for lost property values;
  • Whether you are receiving interest as part of the settlement; and
  • Whether you receive punitive damages.

Damages for Physical Injuries, Emotional Distress or Mental Anguish

Generally, if you receive a personal injury settlement for physical injuries or sickness, including emotional distress or mental anguish that resulted from the actions of another, you do not have to include those settlement proceeds as part of your income. There is one exception to this rule. If you deducted medical expenses the previous years due to these injuries and you received a tax benefit from those deductions, you may need to claim those portions of your settlement for medical expenses.

If you receive compensation for emotional distress or mental anguish that do not originate from a physical injury or sickness, then those damages must be claimed as part of your income. These amounts may be reduced if certain factors are present. Speaking with a knowledgeable tax professional is advised.

Damages for Lost Profits

If you suffered from loss of profits from your business due to an accident that caused you personal injuries and you receive a settlement for those lost profits, this compensation is considered net earnings subject to self-employment tax. These damages must be included as “business income” on your tax return.

Damages for Loss of Property Value

Personal injury settlements that include damages for loss to property value, and that are less than the adjusted basis of that property are generally not taxable and do not need to be reported on your tax return. If the amount exceeds the adjusted basis of your property, then that excess income must be claimed.

Damages that Include Interest

Any part of your personal injury settlement that includes interest will be subject to income tax and must be reported.

Punitive Damages

Punitive damages are sometimes awarded when the defendant’s actions are so bad that the judge feels that general damages are not enough to teach that person a lesson. If your award includes punitive damages, that part of your award will be taxable as “other income.”

It is always a good idea to talk with an experienced tax professional about how to handle a personal injury settlement.

Have You Been Injured in an Accident?

If you or someone you love has been injured by the acts of another person, it is helpful to speak with an experienced personal injury attorney as soon as possible. The law firm of J&Y represents personal injury victims in Los Angeles, San Diego, and throughout the State of California. Contact us today for a free consultation at 888.806.6722.