We’re getting close to everyone’s favorite time of year. No, not the holiday season. In just a couple short months, W2s will start going out and tax season will officially begin. Whether you’re a contractor, own your own business or are employed by someone else, taxes can get really confusing — especially if you’re planning on deductions to lower your payment to Uncle Sam.
If you received a personal injury or wrongful death settlement or judgment in the past year, trying to figure out what portion of it you need to save to give the government only adds another wrinkle to tax season. Luckily, figuring out what taxes you owe, if any, in this situation is rather straightforward.
Physical Injury Is Generally Non-Taxable
If your settlement or judgment was based solely on physical injury, the compensatory damages awarded are generally not taxable by the state or federal government. This payment is intended to cover lost wages, medical bills, attorney fees and other expenses that arose from the injury itself.
Wrongful death settlements fall under the umbrella of physical injury, so they are also not outright taxable. As you can imagine, there are a few different exceptions to these guidelines that should be considered.
Punitive Awards Are Taxable
In some cases, punitive damages are awarded on top of the personal injury or wrongful death settlement. Often, this arises in cases of severe recklessness by an individual or, more commonly, a business that caused the injury or death. Punitive damages are imposed to punish the guilty party and deter future similar action by said party or anyone else who may commit the same action.
Unlike compensatory damages, any punitive damages awarded to you are considered taxable income and must be reported to the IRS. Your attorney will usually make sure the verdict handed down or the settlement reached is divided into compensatory damages and punitive damages so it’s easier to report.
Emotional Injury Damages Are Also Taxed
Damages that are awarded after a physical injury can include compensation for emotional factors, like loss of consortium or mental anguish. However, if emotional damage did not arise from even the slightest amount of physical injury, the damages awarded are taxable. These kinds of case may arise from issues like workplace discrimination or just emotional distress.
Other Exceptions to the Rule
In both personal injury and wrongful death cases, there are other exceptions to the no-tax rule that should be considered. If there is interest accrued on the settlement or verdict, that interest is taxable. For example, if you filed your lawsuit on June 1, 2016, and the settlement or verdict wasn’t handed down until August 1, 2017, you would receive interest for that one year and two months you waited for payment.
Another exception is medical bill deductions. If you deducted medical expenses related to your injury in previous years, you must include that same amount deducted as income after you receive your settlement or verdict. Figuring how much you must report as income to cover these deductions can become complicated, so it may be wise to speak with an attorney or accountant about your situation.
Finally, though wrongful death settlements aren’t outright taxable, there are some cases where you will have to end up paying Uncle Sam based on estate taxes. For 2017 taxes, if your deceased loved one’s estate totals at least $5.49 million after the settlement, the federal government imposes a 40 percent estate tax. The new tax bill proposed by President Donald Trump seeks to eliminate this tax altogether, but for now, it’s something that may need to be considered if you received a wrongful death settlement.
Get Expert Help If You Received a Personal Injury Settlement
There are any number of factors that could affect whether or not you need to pay taxes on your settlement or verdict. While this article provides a useful guideline to consider, it’s by no means exhaustive. If you have received damages for personal injury or wrongful death, it’s always best to speak with a tax attorney or your accountant to make sure you aren’t over- or under-reporting income.