Are Personal Injury Settlements Taxable?
Typically, whether or not the federal government deems awarded court damages to be taxable depends on whether or not the damages directly stem from a physical illness or injury. Damages associated with a physical illness or injury are not recognized as gross income, and therefore are not taxed at the federal level. Therefore, the large majority of damages awarded in personal injury lawsuits are not taxable. The following rules apply both to personal injury settlements made before trial, and judgments made once a trial has completed.
What damages are not taxable in personal injury settlements, and why?
Compensatory damages arising from a personal injury
As the tort’s name implies, Personal Injury lawsuits are almost always associated with some sort of damages arising from the infliction of a physical contact. When this physical contact rises to the level of an injury, damages are typically awarded to the person harmed. Those damages which are directly associated with the physical injury or sickness are not taxable in the eyes of the federal government because they represent compensatory damages.
Damages such as medical bills, lost wages, and pain and suffering are not taxable because those damages directly result from a physical injury. For example, if a client wins a case in which he or she was hit and injured by a drunk driver, all of her medical bills would be tax-free. This would include hospital bills and bills associated with therapy to treat emotional distress stemming from her accident.
Further, if the victim passed away as a result of her crash, his or her family can bring a wrongful death lawsuit against the driver or the driver’s company. If the family wins the case, any and all damages would be tax-free because they are the result of a physical harm suffered by the deceased. However, personal injury cases can also involve certain types of damages which by definition are not awarded as a result of the physical injury. Because the large majority of damages in personal injury lawsuits are not taxable, it is easier to stipulate the types that are taxable.
What damages are taxable in a personal injury lawsuit, and why?
If your personal injury case involves punitive damages, the federal government would tax those. This is because punitive damages are not awarded in order to compensate the plaintiff; rather, they exist only to punish the defendant. When punitive damages are awarded, the court typically stipulates exactly how much of the damages are punitive (taxable), and how much are compensatory (tax-free). This makes it easier for the plaintiff to accurately file their taxes for the year in which the damages are awarded. Therefore, the more money the client wins in compensatory, the more money they save when they file their taxes.
Interest on Damages
Any interest accrued from any damages are taxable, even if those damages stem from a physical injury or sickness. Tax issues involving interest often arise when a judgment is appealed, which can sometimes result in the money not being paid out for years, and thus accruing interest. Similar to punitive damages, interest on damages is taxed because the amount in interest does not represent compensatory damages.
Damages arising out of a lawsuit which does not involve a physical injury
All damages which do not involve a physical personal injury are taxable. This includes damages arising from breach of contract, emotional distress which is not associated with a personal injury (workplace verbal harassment, for example), and damages involving some sort of nuisance.
Contact Houston Attorney Michael P. Fleming if you have questions about your case 713-221-6800.