You might wonder about the tax consequences of recovering personal injury compensation, whether in a claim or lawsuit. Understanding state and federal tax laws is crucial regardless of how you settle your case. You should know when to include your financial award while filing your taxes and what you can exempt.
Typically, personal injury settlements are not taxable. However, specific exceptions can apply, requiring you to report a portion of your settlement to the Internal Revenue Service (IRS). You should hire a knowledgeable personal injury attorney for assistance with your case and an explanation of the requirements you must meet after recovering compensation. They can guide you through each aspect of your monetary award and explain the applicable tax laws.
Here we explain the types of compensation subject to taxation in a personal injury case.
Settlement to Compensate for a Physical Injury
The purpose of compensating someone for their compensatory losses is to make them whole after an accident. Compensation should cover pain and suffering, lost wages, emotional distress, and medical treatment. New York State and the IRS typically don’t tax this type of compensation.
Below is a breakdown of each compensatory loss and the corresponding laws regarding taxes.
A personal injury case must involve a physical injury or illness resulting from someone else’s actions. For example, a car accident is a common personal injury case. You might hit your head on the dashboard and get a concussion after someone runs a red light and hits you with their vehicle. That is a physical injury due to another driver’s negligence.
The settlement you receive must primarily compensate you for the physical injury you sustained in the accident due to someone’s negligent behavior. If you experience emotional distress, physical pain, and other manifestations of the injury, it is not taxable because your symptoms relate to your physical injury.
Your settlement isn’t subject to state or federal taxes if the emotional distress you endured is a direct cause or result of your physical injury from the accident. However, if you experience emotional distress after an accident without an associated physical injury, the state and IRS will likely require you to pay taxes on that portion of your settlement.
You might have to pay out of pocket to treat mental anguish or emotional distress related to your injury. If the insurance company reimburses you for those medical expenses, it likely isn’t taxable.
Lost Wages Due to an Injury
Compensatory losses include lost wages and loss of future earnings. If your settlement compensates you for your past and future lost wages due to your physical injuries, you typically will not have to pay taxes on them.
Compensatory losses and punitive damages differ significantly. Punitive damages are financial awards that punish defendants for their misconduct. It isn’t a means of compensating the accident victim for their losses. Although punitive damages are rare, understanding how they work is essential.
Punitive damages are taxable in New York. You must distinguish between this part of the financial award and the parts awarded for each compensatory loss. Identifying the amount to report on your taxes is crucial to avoid potential issues. You must report punitive damages as income on your federal tax return.
Deductions for Prior Out-of-Pocket Medical Bills
You must declare your out-of-pocket medical expenses as income while filing your taxes if you deduct them from your tax return one year and receive reimbursement the following year.
Lost Income in an Employment Case
Since a personal injury settlement can include lost wages, it is not subject to taxes. However, compensation for your lost wages is taxable if it involves an employment-related matter, such as wrongful termination or discrimination.
Interest on Settlements
Interest might accumulate on your personal injury settlement. Any interest that accrues between when the accident occurs and when you receive compensation is subject to federal and state taxes. That means you must include it as income while filing your tax return.
How a New York Personal Injury Lawyer Can Help
Although securing compensation in a personal injury case is rewarding, knowing how to handle the money is critical. To avoid future obligations or legal consequences, you must determine whether any part of your settlement is taxable. Our legal team can inform you of the basics but also recommends you consult an accountant for more specific details about your situation.
Harris Keenan & Goldfarb has fought for accident victims since 1997. We always work as a team to give our clients the attention and care they deserve. You will receive aggressive representation and a dedication to achieving satisfactory and exemplary results until the end.
If you sustained injuries in an accident that someone else caused, call us at 800-PAIN-LAW or dial #PAIN for a free case consultation today.