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Are Personal Injury Settlements Taxable?

1040 Individual Tax ReturnA common question asked by our personal injury clients at The Jeff Brooke Team is whether the financial recovery in a personal injury settlement is taxable. While tax advice for a specific, individual situation should always come from an qualified tax professional, there are some general tax rules that apply to payments received from a personal injury settlement or verdict.

In most cases, money received for a personal injury will not be taxed under federal or state law, as long as the compensation relates to the physical injuries of the victim. However, as with any tax matter, there are exceptions and qualifications.

A personal injury settlement or verdict typically has a number of different components that make up the total amount. The categories of damages can include compensation for medical expenses, lost wages, future medical treatment, permanent disability, loss of earning potential, pain and suffering, property damage, attorney’s fees, and, in some cases, punitive damages. Classification of the damages can make a difference in whether the payments are taxable.

Compensation for Physical Injuries

Whether the payment is from a settlement or court verdict, financial compensation for physical injuries or physical sickness are not taxable, including payments for medical expenses (past and future), lost wages, loss of earning capacity, permanent disability, and pain and suffering. Payments for emotional distress or mental anguish that originate from the injury or sickness are included in the exclusion. Payments for emotional distress that are not related to a physical injury or sickness likely will be taxable as income.

If some of the proceeds for the personal injury claim were for medical expenses that were deducted and resulted in a tax benefit in prior tax years, that amount of the reimbursement may need to be reported as income. Consulting with a tax professional is always advisable in that situation.

The general tax rules described above apply to settlements in personal injury cases. Settlements in other types of lawsuits or claims may be treated differently under tax law.

Payments for Property Damage

If there is a property damage component to the settlement or verdict, such as damage to a car, the payment may or may not be taxable. If the payment is less than the adjusted basis of the property, it will not be taxable and does not need to be reported. The payment will, however, reduce the cost basis for the property by the amount of the settlement. If the payment is more than the adjusted basis of the property, the excess amount may be taxable as income.

Interest Payments

If the total payment includes interest on the settlement amount, that interest generally will be taxable as “interest income” and must be reported.

Punitive Damages

Unlike the other components of a personal injury settlement, any payments for punitive damages are always taxable and are required to be reported as income.

Allocation of Settlement Payments

Since the different categories of compensation in your settlement can make a difference in whether the amounts are taxable, an experienced personal injury attorney will ensure that the settlement itself is clear on the payment allocation. While the Internal Revenue Service does have the right to challenge non-taxability of a personal injury settlement, having a settlement document that specifies the allocation is the best way to make certain that the reason for specific payments is clear.

Is Your Personal Injury Settlement Taxable?

The rules above are only general guidelines for settlements in a personal injury claim. If you have a negotiated settlement or jury verdict in a personal injury case, the only way to be certain that the settlement is properly reported on your taxes is to consult with a qualified tax professional. The individual facts in a specific case and terms of the settlement or verdict will determine taxability of the different components of the compensation amount.

Talk With a Virginia Beach Personal Injury Attorney

If you or a loved one suffered catastrophic injuries in a Virginia accident that was another person’s fault — or if you’ve lost a loved one in an accident — The Jeff Brooke Team can help. It is always advisable to talk with a personal injury attorney before you talk with the at-fault person’s insurance company. Experienced Virginia Beach accident lawyer Jeff Brooke is dedicated to helping clients and their families recover the compensation they deserve. Contact us by phone at (757) 785-0837 or by using our online contact form.

Jeff Brooke is a personal injury attorney devoted to helping individuals who have suffered serious and catastrophic injuries or lost a loved one as a result of someone else’s negligent and careless actions. The Jeff Brooke Team serves all of southeastern Virginia. The firm helps clients in the Greater Tidewater and Greater Hampton Roads areas, including in Virginia Beach, Norfolk, Portsmouth, Chesapeake, and Chesterfield. The Jeff Brooke Team also handles cases in northeastern North Carolina, including the Outer Banks.

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