This is an article by Modoline Altenor, your personal injury attorney serving all of greater Orlando.
Do You Pay Tax On Personal Injury Compensation?
Settling a personal injury lawsuit is (usually) a good feeling.
It means you and your personal injury law firm were strong.
It means the end of a legal dispute and the arrival of your just compensation. It means you received justice – and it means you survived, and kept going, and made it through something that was assuredly very difficult.
Perhaps you handled a claim by yourself. Perhaps you hired a personal injury law firm to increase your compensation. No matter which way you chose to go, you hopefully got money in return for the damages done to you.
With tax season always approaching (or so it often feels), you may be wondering if the money you received in your settlement or judgment is going to be taxed.
The Short Answer
Most of the time, your personal injury settlement is non-taxable.
The REAL Answer
“Most of the time” means “not all of the time.”
There are scenarios in which your settlement can be subject to taxation. In this article, we’ll go over what those are, so you can handle your money appropriately and make the smartest decisions available to you.
There are several exceptions and exclusions to that “most of the time” rule. If you qualify for them, part or all of your settlement or jury award could be taxed.
Here’s what the IRS has to say on the matter:
When you work at a job, your wages, salary and tips are taxable income. Personal injury or lawsuit settlements are instead considered “compensatory income.” In short that means that it is money meant to compensate you for a loss or injury you sustained.
Compensatory income is surrounded by rules that can feel somewhat vague. While many assume that the term is synonymous with ‘nontaxable,’ that isn’t always the case. Making that assumption without doing your due diligence could leave you owing substantial back taxes.
So what is taxable and what isn’t?
According to the IRS, the following portions of your personal injury settlement cannot be taxed:
Money received in compensation for physical injuries.
Money received in compensation for emotional distress caused by physical injuries.
Lost wages resulting from physical injuries.
So, in short, money paid to you to compensate you for injury, lost income, medical bills, and pain and suffering are all specifically tax-free.
But wait, you’re thinking, isn’t that basically everything?
That isn’t enough to keep you in the clear, we’re afraid. As an Orlando personal injury law firm, we’ve encountered any number of scenarios that didn’t fall under those criteria – and our clients wouldn’t have known any better!
As far as what IS taxable …
The exceptions to the general rules aren’t difficult to navigate, you just have to know them. Depending on how you’ve handled your settlement and your past tax history, you could still owe the IRS.
If you’ve received tax breaks or benefits related to your case, you may not be able to claim additional benefits or treat the income as non-taxable. For instance, if you’ve already used deductions to defray your income taxes, and those deductions included the out-of-pocket cost of your medical care.
That’s legal, but you can’t double dip. That means that, once you’ve been compensated for those expenses, you have to pay back the amount deducted in the previous year. When you go to file taxes, your accountant will put this amount in as “other income,” and you will pay back taxes on it.
You are required to pay taxes on interest on money recovered during a personal injury lawsuit. If your settlement spends the year sitting in a savings account and earns back interest, it is considered “interest income” and you will have to pay taxes on it.
Wages, unemployment, operating income, SSI, alimony, and self-employment income are exempt from this requirement, but your settlement money is not. SO keep track of how your settlement money is spent.
Interest & Dividends
Income from trading and commodities
Orlando Personal Injury Law: Are Punitive Damages Taxed?
Punitive damages are different than compensatory damages. When you are awarded punitive damages, it is not intended to compensate you for your injury, but rather to punish the at-fault party for negligence. It’s relatively rare, but definitely not unheard of.
In any event, punitive damages are NOT “compensatory income,” which means they are taxed as income, even in a personal injury lawsuit.
Failing to report this income on your tax return could spell trouble from the IRS. It belongs under “other income” on your 1040.
If your law firm received a large enough settlement on your behalf, you could be expected to make estimated tax payments quarterly, so make sure that you speak to your personal injury attorney as well as an accountant, and ensure that your financials are being handled accordingly.
As always, failure to report income properly could lead to penalties.
If you don’t have any close friends or relatives to turn to, consider speaking to a central figure in your community. This could be a pastor, a councilperson, a medical professional, an accountant, or something else. Pillars of the community are more likely to have heard the good, the bad and the ugly about local lawyers.
At the Altenor Law Firm, we pride ourselves on our relationship with the Orlando community. You can ask around about us – we have nothing to hide, and a great deal in which to take pride.
When you’ve got some names, we recommend a phone call before taking any next steps. Sure, you can submit cases online to a lot of lawyers, but that’s not your best foot forward. A lot can be taken out of context online. Speaking to a person engages your instincts.
When it comes to choosing a lawyer, instincts matter.
Alright: you’ve hired the best personal injury lawyer Orlando – or wherever you’re reading this from – has to offer, and you’re quite confident that you know how taxes will affect your settlement.
That doesn’t necessarily mean that you’re in the clear. In fact, there are several other things to watch out for once you’ve received your money. The most important of these are liens against you. If you’ve got debts owed to your health insurance company or have liens due to funding during your recovery process, you have to pay those off.
A good personal injury law firm will already know all of this, and will have helped you take care of all of that.
However, if you’ve made the mistake of hiring the wrong lawyer, or settled your claim without one, you might be left in the dark. A good personal injury law firm will already know all of this, and will have helped you take care of all of that.
Unfortunately, saying “I didn’t know” doesn’t help you when it comes to debts and liens. You should always ask your lawyer or at the very least a tax accountant for help ensuring that you’ve paid all of the appropriate people what they’re owed before you start earmarking things your settlement money will buy.
In any personal injury lawsuit with a complicated judgment or settlement – like those with punitive damages – it can be difficult to determine what percentage of your settlement money is taxable.
You don’t want to guess wrong when it comes to tax liability.
Reach out to us – the personal injury lawyers here at the Altenor Law Firm are among the most tenacious and experienced you could ever hope to encounter, and we will do everything in our power to get you maximum compensation with minimum taxation.
Let Us Help You – The Altenor Personal Injury Law Firm
Handling a claim is as important as winning a settlement. If you forget to account for taxes when agreeing to a settlement, you could end up with a great deal less money, when all is said and done, than you had hoped. Working with an experienced Orlando personal injury attorney like us is a sure way to avoid pitfalls. Let us handle insurance companies, doctors, treatment facilities, and defendants’ counsel for you.
We make sure that your claim accounts for potential taxes, so that you get what you need and can focus on your own wellbeing.
In 2018, Donald Trump altered the way personal injury settlements are taxed – and unfortunately not for the better. Under the Trump tax law, in order to qualify for tax-free treatment, injuries must be physical. Emotional damages and symptoms like insomnia and headaches are now considered taxable.
How does this work? It’s confusing, even to the law firms.
If you make a claim for emotional distress, those damages are taxable. If you claim the defendant made you physically ill, they are not.
Then, if you claim that emotional distress made you physically ill, under the current law, those damages are taxable again.
Then, if you claim that physical injuries caused emotional distress, it’s possible that those damages will be tax-free, because they began with a physical injury.
Thus, it’s a chicken-egg scenario, and the words you use while making your case have become more important than ever.
Further, the law changes how contingency fees work. Often, personal injury law firms don’t earn money unless they win your case – and then they take an agreed-upon percentage of your settlement as their fee.
Under previous law, those lawyer fees were usually considered non-taxable income, just like the rest of your settlement, so if your settlement of $100,000 included a $30,000 payout to your lawyer, you wouldn’t need to worry about paying on their share.
Under new law, if part of your settlement is taxable, it could spell real trouble for you – you could be paying taxes on the entire settlement, including the lawyer fees. There are exceptions to this – if the claim involves your business, it could be a deductible line item – but in general, it’s another thing that must be accounted for during negotiation.
That’s why it’s more important than ever that you don’t enter into personal injury lawsuits without expert advice. We can protect you from all of this, and more, and ensure that the final amount paid to you will be enough to fully compensate you for your losses and injuries.