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Following the settlement of a personal injury lawsuit, our DC personal injury lawyers are often asked whether the payout is subject to income tax. In most cases, personal injury settlements are not considered taxable income at the federal and state level.
However, there are specific exceptions to this general rule. The taxability of a settlement can depend on the nature of the damages awarded.
Learn more about the different types of settlements and if yours is taxable.
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Personal injury law encompasses all lawsuits where one party alleges that someone else’s negligence caused them physical injury. Rather than going to trial, most personal injury cases can be settled out of court. Typically, the claimant’s (injured person) personal injury attorney will assess all the losses the claimant incurred and combine those into a single sum. This sum will then be presented to the defendant and their legal team, who can either agree to the offer or counter with an offer of their own. The settlement money is intended to compensate the claimant for the medical expenses, lost wages, and emotional distress caused by their injuries.
If you have received a personal injury settlement or are negotiating for one, you may wonder how much of this money I will see? Will it be taxed? These are important questions to ask, and the answer is most personal injury settlements are not taxable, but there are exceptions.
The federal government does not tax the settlement money awarded in physical injury cases. This means that if you were in a car accident caused by another driver’s recklessness and experienced physical injury from the accident, any settlement money you are awarded is free from taxation on the federal level. This is because the money is intended to compensate for losses you’ve endured (medical bills, lost wages, and more).
Sometimes, a claimant will seek compensatory damages for a situation in which things like emotional distress, pain and suffering, and mental anguish occurred, but there was no actual physical injury. For example, a person was almost hit by a drunk driver but narrowly avoided the collision. In the aftermath of the near accident, this individual might be suffering from things like PTSD and anxiety, which certainly constitute pain and suffering. However, they did not endure any actual physical harm to their body. In a case like this, which revolves solely around emotional distress, it is possible for the damages to be taxed.
It’s important to remember that this does not apply to cases where physical injury or sickness occurred alongside emotional distress and mental anguish. These cases are almost always tax-free. A settlement recipient must pay taxes only if the case in question involved no element of physical injury.
As discussed above, compensatory damages awarded in a personal injury settlement are intended to compensate the injured party for the losses they’ve experienced. However, another category of damages differs slightly: these are known as “punitive damages.” Unlike regular damages, these are intended not to compensate the victim but to punish the defendant.
Typically, these are only called for in more extreme cases where the defendant committed gross negligence. One of the more common instances where these damages come into play is drunk driving cases. The intention is to dissuade them and others from exhibiting such gross negligence. Typically, the victim of the negligence is the one to receive this compensation, as the defendant’s negligence harmed them.
Unlike compensatory damages, the Internal Revenue Service sees punitive damages as income and, therefore, taxable.
A wrongful death claim occurs when a victim’s family member initiates a personal injury case on the deceased party’s behalf. The idea behind these claims is that had the deceased party survived, they would have been entitled to pursue a personal injury case. As they cannot advocate for themselves, their surviving family members are legally entitled to pursue the claim instead.
In Washington, DC, wrongful death lawsuit settlements are not taxed. This money is not taxable if you receive a settlement in a personal injury case. This includes compensatory damages for lost wages, medical expenses, funeral expenses, loss of companionship, and more — all are non-taxable in these types of settlements.
While your compensatory damages from a personal injury claim are generally not taxable, there are a few exceptions to the rule.
Sometimes, you may claim an exemption for a medical bill in your income taxes but later receive a settlement that compensates you for that same bill. In this situation, the Internal Revenue Service (IRS) dictates that you report these damages as taxable income. This is known as “recapturing” the previously deducted amount.
Car accidents commonly result in a property damage settlement check for the cost of the damaged or totaled car. However, if the amount you receive exceeds your property’s adjusted basis (value), you must pay taxes on the excess amount, not the entire settlement.
Gross income represents the total amount you’ve earned or collected from any sources in a given year before any taxes and deductions are taken out. You may wonder if your settlement should be factored into your gross income and included on your tax return.
The IRS states that “gross income does not include damages received on account of personal physical injuries and physical injuries.” In other words, if you received a settlement in a personal injury case that involved physical harm to your person, these earnings are exempt and not subject to taxation. They, therefore, do not need to be included on your tax return.
One of the best ways to ensure a successful outcome and a satisfactory personal injury settlement is to work with an experienced attorney. Your lawyer will be the first line of defense as you work to secure a personal injury settlement — they will negotiate with the at-fault party for as long as it takes until both sides can agree on a settlement amount. If a settlement cannot be agreed upon and a trial becomes necessary, your attorney can protect you in the courtroom and continue fighting on your behalf.
An experienced attorney can help you minimize your tax obligation and handle all tax situations correctly. Regan Zambri Long personal injury lawyers have decades of expertise and can assist you in understanding the tax implications of personal injury settlements in DC. Call us for a free consultation today.
Additionally, consulting with a tax attorney to ensure you are handling the funds correctly and reporting anything that needs to be reported for tax purposes can also be helpful. They can review all the details of your settlement and ensure you’re properly reporting and paying taxes where you need to.
