Are Personal Injury Settlements and Court Awards Considered Taxable Income?
So you’ve won your personal injury lawsuit and have received compensation, either in the form of a negotiated settlement or a court ordered award, but what now? Is that money yours for the keeping, or will you need to pay tax over it? The answer to this question is a bit complicated and depends on what exactly it is that you’re being compensated for. Read on for general information about when the IRS considers personal injury settlements and awards taxable, and keep in mind that state tax codes generally follow the Federal Tax Code’s lead on this matter.
The General Rule
The general rule is that the Internal Revenue Service (IRS) does not consider proceeds from personal injury claims that are paid in compensation for personal physical injuries or physical sickness to be taxable income. This rule of thumb applies regardless of whether your claim was settled outside of court or was resolved via a court issued award. However, if you are familiar with federal tax law then you are probably aware that when it comes to tax laws there is almost always an exception to every rule. This is certainly true when talking about taxing proceeds from personal injury claims, so be sure to note the various exceptions outlined below.
Exceptions to the General Rule
According to the IRS, common exceptions to the general rule that personal injury settlements and awards are not taxable include damages paid for:
- Emotional Distress or Mental Anguish: If the proceeds that an injured party receives are for emotional distress or mental anguish do not originate from a physical injury or sickness then they are taxable. However, keep in mind that damages paid for emotional distress and mental anguish that originated from a physical personal injury or physical sickness are not
- Lost Wages or Profits: Damages awarded in order to compensate an injured party for lost wages, loss of income, or lost profits is considered taxable income when recovered in connection with a personal injury lawsuit.
- Interest: Many courts include an interest payment in personal injury awards based on the length of time that a case has been pending. These interest payments are always taxable and must be reported as income.
- Punitive Purposes: Punitive damages are awarded in order to punish a defendant (opposed to other types of damages that are awarded in order to compensate the injured party) and are generally only issued in personal injury cases where the defendant was grossly negligent or intentionally caused the plaintiff’s injury. When these damages are awarded in personal injury cases they are taxable (even if the were received in connection with compensation for a personal physical injury or sickness).
Need Legal Advice?
A good personal injury attorney will not only fight for the compensation that you are legally entitled to but will also work to ensure that your settlement or award is structured in such a way that you walk away with the best possible tax situation allowed by law. If you are looking for an experienced personal injury lawyer to represent your in either New Mexico or Texas contact the Lovett Law Firm today to schedule a free no obligation initial consultation.