You Won Your Personal Injury Case! Is Your Settlement Taxable?
Being injured in an accident is a very daunting experience in and of itself. If you’ve decided to file a personal injury lawsuit related to your accident, you might feel particularly overwhelmed by everything that’s going on related to your case in addition to all that you need to do to continue to recover from your accident. Once the lawsuit has been filed and you either settle out of court or are awarded a judgement, it’s a relief to know that you finally have the compensation you need to cover the expenses stemming from your accident. But when tax season rolls around again, you may be left facing a big question: is my settlement or judgement taxable?
Many types of legal settlements and judgement are taxable. However, personal injury lawsuits are different. Generally speaking, settlements and judgments for personal injury cases are not taxable. Regardless if you settled out of court or if a court awarded you a judgement, if you recover damages related to an injury or sickness, that is not taxable on a state or federal level. This includes damages for things like medical expenses, lost wages, emotional distress directly caused by the accident, and compensation for attorney fees. In situations where a person files a lawsuit on behalf of a spouse who died in an accident, they may be awarded loss of consortium damages, which are also not taxable since they are directly related to the injury.
Although personal injury lawsuits generally aren’t taxable, there are some important exceptions to be aware of. First of all, if your settlement/judgement has accrued interest, the interest is taxable. Also, if your case involved punitive damages, those punitive damages are almost always taxable. Since punitive damages are intended to punish those who behave in a negligent manner, the IRS treats them differently from other types of damages related to personal injuries. The only exception would be if you live in a state where punitive damages are the only type of damages that can be awarded in a wrongful death lawsuit.
It’s also very important to note that the general rule about personal injury lawsuit settlements not being taxable only applies to physical injuries and illnesses. Serious accidents can indeed cause emotional distress and if you are awarded emotional distress damages as part of a personal injury lawsuit, that’s not taxable. But if you only sued for emotional distress over something like harassment or slander/libel, those types of settlements would be taxable.
On a related note, settlements for lost wages also have to be directly related to a physical injury for them to be tax free. For example, let’s say someone spread a malicious, untrue rumor about you, causing you to either lose your job or causing a business you own to lose customers. In either case, you lost out on income because of their actions. But since this case does not involve any physical injuries, your settlement/judgement would be taxable.