If you have been injured in an accident, a personal injury attorney can work with you to help you achieve a settlement that fairly compensates you for your losses. One question that arises for many people is whether they are required to pay taxes on settlements for their personal injury cases. The answer depends on the facts of your particular case, including how your settlement was structured.
There are several different items of damages that may be included in a personal injury settlement, such as compensation for medical expenses both past and future, lost wages again both past and future, property damage, rental car expenses, tow and storage charges, loss of credit worthiness, emotional distress and in some cases interest on a judgment. Under very unique circumstances, a personal injury settlement may also include compensation for punitive damages, which are meant to punish a wrongdoer.
The Internal Revenue Service (IRS) will tax certain types of damages in a personal injury settlement and not tax others. As a general rule, damages that are intended to compensate victims, or to make them whole again, are not taxed by California or the IRS. However, this rule has certain exceptions,
Compensation that is intended to reimburse you for the cost of repairing the damages to your vehicle, the cost of renting a replacement vehicle during the time your car is being repaired, and the cost of towing and storage are typically not taxable.
For example, you may be required to pay taxes on medical expenses as part of your settlement, but only if you took an itemized deduction for medical expenses in previous years and you paid medical costs for more than one year. Otherwise, the full amount of your compensation for past and future medical expenses is tax-free.
Similarly, compensation for pain and suffering, otherwise known as non-economic damages, which result from a physical injury are not taxable. There are some exceptions to this general rule.
Compensation for past and future lost earnings is taxable in the same way that your earnings are taxable.
Compensation for accrued interest on a judgment, or for punitive damages is also taxable.
Working with a tax professional will help to ensure that you pay the appropriate taxes on your personal injury settlement.
An experienced personal injury attorney can help you understand the terms of your settlement, and whether any part of your settlement is subject to taxation under both Federal and State law. Of course, you should also consult with a qualified tax advisor, such as a CPA or tax accountant, to ensure that the proceeds from your settlement are properly reported.
