Tax Consequences of a Personal Injury Settlement

Have you been injured in a car accident?

Hopefully you have been financially compensated for your injuries through a settlement, but the last thing you want to do now is have to pay taxes on this money.  The good news is that you likely won't have to.

Whether your settlement is taxable depends upon how the settlement is classified.

Personal Injury
If you receive a settlement for personal physical injuries, and did not take an itemized deduction for medical expenses related to the injury in prior years, the full amount is non-taxable.  However, if you claimed medical expenses related to the injury in a prior year, you must include that portion of the settlement in income.

Emotional Distress or Mental Anguish
If a portion of your settlement is for emotional distress or mental anguished originating from a personal physical injury, then it too is non-taxable.  However, the emotional distress or mental anguish must originate from a personal physical injury.

Lost Wages
If a portion of your settlement is for lost wages, that portion is fully taxable.

Property's Loss-in-Value
The taxable portion of a settlement relating to your property's decrease in value depends upon your basis in the property (original purchase price less any allowable deprecation).  If the decrease in value is less than the adjusted basis of your property, that portion of the settlement is not taxable.  However, if the property settlement exceeds your basis in the property, the excess is taxable income.

Punitive Damages
Punitive damages are fully taxable, even in personal injury cases.

It is very important when your attorney is negotiating a settlement that he/she classifies the settlement in a way that minimizes your tax burden.  The IRS will generally respect the classification of the settlement as long as it is consistent with the type of injury suffered.

If you have any questions about the taxability of a legal settlement, or if you would like a referral to a great personal injury attorney, please do not hesitate to send me an e-mail.

As always, I appreciate you leaving your feedback in the comment section below.