Tax Issues Involving Personal Injury Settlements Can Be Complex: Learn the Basics
Many personal injury cases take years to get settled or for a jury decision. When it finally happens and you have money in your hand, it can be easy to want to put on your blinders and simply move on with your life. Unfortunately, there are still a few issues to deal with – including tax issues related to your settlement or jury award.
If you are wondering if personal injury winnings are taxable, the bad news is that the answer is not as simple as a yes or no: Some are taxable and some are not. If the money is taxable and taxes are not paid on it, the IRS can become involved and the situation can get very serious very fast. The best way to be sure about the tax ramifications of any money you have won is to talk to a tax accountant. However, we are happy to share some basic facts about these cases.
First: The Two Types of Damages
There are two main types of damages: Compensatory and punitive. Compensatory damages are those that are awarded due to actual loses that occurred as the result of proven harm. For example, this would include damages for physical injuries, emotional distress, and medical costs. Punitive damages are awarded to punish the at-fault party – not to compensate the plaintiff for their costs.
Some Damages Are Taxable and Some Are Not
It is rare for punitive damages to be issued but when they are, they are always taxable. According to the IRS, they are not awarded as a loss, which is the reason they are always taxable. Compensatory damages, on the other hand, can be taxable or not – largely due to why the lawsuit was filed in the first place.
Think of it like this. Compensatory damages awarded for any physical injury are not taxable. However, the injury must be visible. As a result, damages for any type of non-visible injuries such as defamation, pain and suffering, or other internal injuries would be taxable – for the most part.
Once again, it is not quite that simple. If emotional distress is listed as a damage for the lawsuit, it will depend on what the damage was. If it was a physical symptom caused by emotional distress, it would be taxable because the injury – emotional distress – is “invisible.” On the other hand, if damages were awarded for physical injury or sickness that then led to emotional distress, the damages would not be taxed. Once again, the “injury” is physical even if the consequences and symptoms – emotional distress – are not.
Does this sound confusing? That is because it is. When you work with Law Offices of Fernando D. Vargas, we can go over the basics of what is likely to be taxable and what will not be taxable. However, the final answers will come from your tax accountant.