When you are involved in a personal injury settlement, taxes are probably the last thing on your mind. However, it is vitally important that you understand the tax implications of receiving any type of personal injury settlement. You do not want to spend so much of your money that you can no longer pay the taxes on it.
Determining which parts of the settlement you need to pay taxes on can be tricky. There are a lot of rules that apply to various personal injury situations. You must look at all the different types of payments you are receiving as part of the settlement.
For example, you might receive money for the physical injury or illness itself. You might also receive money for lost wages or punitive damages. Each of these has different tax implications. We will discuss how you can estimate your tax responsibility by analyzing the breakdown of your settlement in the following sections.
Personal Injury Settlements Are Generally Tax-Free
Typically, any money that you receive in a court settlement should be taxed as income. However, personal injury settlements are an exception to this rule. In general, the money that you might receive from a personal injury settlement is not taxable. The tax implications of these types of settlements vary depending on the payment category, such as if the money is going toward medical expenses, lost wages, or repairs to your property.
If you ever find yourself as a recipient of a personal injury settlement, you should consult with a lawyer to make sure you fully understand the tax situation of your particular case. In the next section, we will discuss the tax implications that could come up in a personal injury settlement.
Types of Payments That You Might Receive in a Personal Injury Settlement
If you are ever the recipient of a personal injury settlement, it will be important to know the different types of payments that you might receive within the settlement. Typically, the money will be considered compensatory damages, meaning that it is supposed to compensate for something that happened during or because of the injury. However, different tax implications depend on what the money compensates for and how much money you are receiving.
The following sections detail the types of payments that you might receive as part of a personal injury settlement. These range from payments intended to compensate for the injury or illness itself to punitive damages. Each category has different tax implications, so it is vital to understand the differences between them.
Physical Injury or Physical Sickness
A physical injury is when someone’s body is damaged by someone else. This damage could include broken bones, head trauma, large wounds, or any other type of injury that requires medical attention. A physical sickness refers to any illness that you contract due to someone else’s negligence. One example of this is mesothelioma, which is caused by exposure to asbestos. If you find that you have mesothelioma and were exposed to asbestos in your workplace or rental property, the business owner or landlord would be held liable for your sickness.
Settlements that you receive due to a physical injury or physical sickness are not taxable in New York and New Jersey.
Emotional Distress and Mental Anguish
It is not uncommon for people to receive settlement money for emotional distress and mental anguish in response to pain and suffering. If you receive settlement money for this, you might have to pay taxes on it, depending on the circumstances of your case.
Suppose you receive settlement money for emotional distress and mental anguish caused by or directly related to a physical injury or illness. In that case, you will not be taxed on the money. However, if there was no injury or illness involved in the incident, then you will likely have to pay taxes on the money.
There is one exception to this rule. If you receive settlement money as reimbursement for specific costs that you paid to treat the anguish and distress, you will probably not be taxed on the money, even if there was no physical injury or illness.
Injury or Illness Related to Loss of Wages
In some cases, part of the settlement that you receive is meant to compensate for lost wages during your treatment and recovery from your injury, as long as the lost wages are directly related to the illness or injury. In these cases, the money is not taxed. This is because the money is considered part of the compensation damages rather than compensation for business loss, like in a wrongful termination situation.
Loss of or Damage to Property
In some cases, the settlement money you receive in a personal injury settlement is meant to compensate for lost or damaged property. It would include things like compensation for a damaged or totaled car in the event of a car accident where you were injured.
In these cases, you must know the value of your property before the incident. In our example above, you would need to know the value of your car. If the money you receive in the settlement is less than the value of your property, then you do not need to pay taxes on it. If you receive more money than the value of your property, then you will need to pay taxes on the money.
Punitive damages are sometimes given to defendants when the judge or jury finds behavior especially harmful. These are typically cash awards given to the plaintiff on top of compensatory damages. While you will generally not need to pay taxes on compensatory damages, you will need to pay them on the additional punitive damages that you might receive.
Previously Deducted Out-of-Pocket Medical Expenses
Often, it can take months or even years to settle a personal injury case. However, the injured party must treat their injury or illness and pay for the associated expenses somehow. In most situations, the injured party will pay for their treatment out of pocket and hope that they receive a settlement at a later date. The injured person would most likely deduct their out-of-pocket medical expenses from their tax return for the year(s) they paid for treatments.
Once the injured party receives their settlement, they must take the amount deducted from their taxes in previous years and declare it as income for the year it was received. In doing this, the injured person must pay taxes on the amount that was previously deducted.
Interest on the Judgement
Again, a lot of time can pass between the original incident that causes the illness or injury and the time when you finally receive your compensation. Because of this, there can be interest that accrues on the settlement amount that you will be paid. The amount of interest on the settlement that you receive during the final payout will be taxed.
When You Might Need To Pay Taxes on Your Personal Injury Settlement
As we have discussed, determining the tax implications of a personal injury settlement can be complicated. There are a lot of gray areas and situations that require a closer look at the specifics of the case. In many cases, the money you receive as part of a personal injury settlement is not taxable. However, there are some exceptions. They are as follows:
- You must pay taxes on the money you receive for emotional distress and mental anguish unless the money compensates for the treatment of emotional distress and mental anguish.
- You must pay taxes on compensation for lost wages if no illness or injury prevented you from working.
- You must pay taxes on money that you receive to compensate for lost or damaged property if the amount exceeds the property’s value before the incident.
- You must pay taxes on any punitive damages that you receive as part of the settlement.
- You must pay taxes on money that you receive as part of a settlement equal to the amount you deducted in previous years for out-of-pocket medical expenses related to the illness or injury.
- You must pay taxes on any interest that accrues on the settlement amount during the trial.
We have given a broad overview of the different types of payments that you might receive as part of a personal injury settlement. Understanding the differences between these types of payments can help you estimate the amount of your settlement that you would have to pay taxes on. However, you should seek advice from an attorney to make sure that you fully understand the tax implications of your specific situation.
Contact Us Today
Have you recently received a settlement for a personal injury? You will want to understand the tax implications in this situation. Depending on the circumstances of your case, you might need to pay taxes on some or all of the money you received. If you find yourself in this situation, it is best to seek legal advice from professionals. That is why we are here. Call the Law Offices of Sadaka Associates at 1 (800) 810-3457 today for a consultation.