A personal injury lawsuit is not a pleasant thing to go through. Beyond having to deal with the injuries and losses that led to the case, the complainants have to undergo the scrutiny of the insurance company’s lawyers and doctors, the rigors of negotiations, and a trial, which can take from months to years. Then you must hope that you will receive your just compensation. Those that have been through the process, rarely consider it a fond memory.
However, as rough as going through a lawsuit can be, it is nothing compared to what you can face, if you land on the wrong side of Uncle Sam and the IRS.
As you can well imagine, the tax code, as it applies to personal injury cases, is no less complicated. So, in the interest of helping you keep as much of your hard-won settlement as possible, I offer you this, very simplified, explanation of when you will owe taxes on your personal injury settlement.
Taxable or Nontaxable Compensation
There are two types of damages, in a personal injury lawsuit, compensatory and punitive.
Punitive Damages
Punitive damages are those that are designed to punish a person or company for what is seen as gross negligence or unlawful behavior.
In comparison to compensatory damages, it is rare to see punitive damages awarded. However, when awarded, they are always taxable.
Compensatory Damages
Here is where things can start to get complicated.
The IRS maintains that compensatory damages are not taxable, provided that the injury is visible. Therefore, in the majority of cases, involving medical injuries such as a slip and fall or auto accidents, your settlement should be tax-free.
The inverse of this is, of course, that if your case involves damages such as defamation of character, sexual harassment, or hostile workplace environment issues, you can expect there to be a tax bill due on your settlement.
Sounds simple right, if you need a doctor, you’re tax-free. Hold on a second. What if you have emotional issues that manifest themselves as physical pain?’
Say you have headaches brought on by the stress of your injuries. Now, the waters start getting a little cloudy. If the wording of your settlement says you are receiving compensation for the emotional distress of the accident, and the headaches are a sign of that distress, you will have to pay taxes on that portion of your compensation that covers those headache treatments. Emotional distress is not considered a visible injury, even if it manifests itself in a physical manner, requiring medical treatment.
Are you confused, yet?
If you are, don’t feel bad. Tax laws are some of the most complex. It has been shown that even IRS agents and lawyers disagree on how they should be interpreted.
I have tried to make this article as clear and concise as possible. However, tax law is not my specialty and the best advice I can really offer is this. Just as you want an attorney who focuses exclusively on personal injury law to handle your personal injury case, it would be best to consult a tax attorney before you file your taxes following a settlement.
It would be tragic to see you lose what you and your attorney have fought so hard to gain because the tax man didn’t get his share.