Many clients worry about what happens to the money they get from compensation for personal injury after a vehicle accident or similar incident. Specifically, they worry if a settlement or trial award will create a large tax burden for them come next April.
The good news is that, generally speaking, most financial compensation for personal injuries will not be taxed. However, each case could have mitigating factors that affect the potential taxability of awards and settlements. Some types of compensation can be taxed, such as loss of income, for instance.
Learn more about the topic so that you are able to discuss your options further with a personal injury lawyer or tax accountant by reading on.
What Are the Relevant Tax Laws to Personal Injury Settlements?
The of U.S. tax code that relates most specifically to lawsuit settlements is covered in 26 C.F.R 1., §1.104-1 Compensation for injuries or sickness:
(c) Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.
What this law means is that anyone who receives a settlement or trial award for any direct costs will not be subject to extra taxation. There are, of course, exceptions, but the general logic goes that these payments are not considered income since they are direct repayments for losses the victim would have otherwise paid out of pocket. Therefore, they do not count as income in most instances.
Federal tax code also extends to compensation for emotional losses, as §1.104-1 continues:
Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.
Likewise, compensation for property damage to your car or other belongings is not taxable in a large majority of instances.
Settlement Amounts That Are Taxable
In tort cases, courts will sometimes grant punitive or exemplary damages, which are designed to punish those who carry out extremely negligent or harmful actions, while deterring others from behaving in kind.
Since these payments do not count as actual reimbursements for quantifiable costs, but rather an abstract damages award related to the actions of the tortfeasor, they are almost always taxed. Individuals should report such compensation on their 1040 tax form or relevant document.
Another type of compensation that is generally taxable is loss of income damages. Since any lost income would have been taxed anyways, the IRS feels compelled to collect taxes on the equivalent compensation.
Reviewing Your Options with a Personal Injury Lawyer
You can never know for sure whether your specific personal injury award or settlement will be taxed, so make sure to review the options at your disposal with an Oklahoma personal injury lawyer who can also refer you to a tax specialist if need be. Contact us today for a free consultation regarding your case.