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Settlements and Taxes: What You Should Know

If you have already received monetary compensation for injuries suffered in an accident or have recently filed a personal injury claim and do not know yet how much compensation you will receive, you should have taxes on your mind. You may worry about the impact, or potential impact if any that a settlement may have on your taxes. You should always speak with a tax professional or your attorney regarding what preparations you should make for taxes when your income changes due to an insurance settlement. Below, however, are some general guidelines regarding this topic.

What the IRS Says

According to the Internal Revenue Service, when someone receives a monetary settlement for personal physical injuries or sickness and did not take an itemized deduction for medical expenses in prior years that relate back to the injury or sickness, the full settlement amount is not taxable. 

Therefore, generally, settlements received from a third party as a result of physical illness or injury are not taxable. Likewise, compensation for mental anguish or emotional distress resulting from the injury are also not taxable. Notably, this applies to the federal level. You should confirm whether your settlement is taxable at the state level, depending on your circumstances. 

Exceptions to No Taxes

There are, however, some situations where you will have to report your settlement to the IRS and you may be expected to pay taxes on this amount.

  • If you have deducted medical expenses relating to your sickness or injuries in your prior years’ taxes. Because it can take quite some time to resolve a personal injury claim, and oftentimes large medical expenses follow an injury, you may have been recommended by your tax preparer to claim those expenses as deductions;
  • If your settlement includes mental anguish or emotional distress damages that were not the result of a physical illness or injury. While these non physical injuries are uncommon, you may need to report this income — although you may be able to deduct medical expenses related to those mental health issues;
  • If your settlement includes punitive damages, which are intended to punish the at-fault party that caused your injuries, you may have received a substantial award. Punitive damages are taxable income, meaning you must report them in the tax year in which they were received;
  • If your settlement includes lost wages, that could be taxable income. If your settlement is for an employment-related lawsuit, the amount will usually include compensation for lost wages. This may include severance, past wages or future wages. It is best to assume that any and all settlements arising from employment-related lawsuits include taxable wages.
  • Sometimes, when a case settles, the wrongdoer may require a confidentiality clause. Any amount of money attributable as compensation for your silence may be taxable.

Las Vegas Attorneys

It should be noted that fear of taxes should not be the driving force of whether you seek damages from someone who has injured you. The experienced Nevada personal injury attorneys at H&P Law will fight for the best outcome possible. Contact us today for an initial evaluation. 

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