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Are Personal Injury Settlements Taxable?

Settlement process

A personal injury lawsuit may allow you to collect damages, including compensation for medical expenses, lost wages, pain, and suffering. But are personal injury settlements taxable? It depends on the type of compensation you receive and previous exemptions you claimed on your tax returns. The Car Crash Experts at Cooper Hurley Injury Lawyers are here to explain the basics regarding taxes on personal injury settlements in Virginia.

Receiving a settlement or court-ordered compensation often comes as a major relief to personal injury victims, many of whom lose their source of income during their recovery from their injuries. As you may have already experienced, bills for medical care and daily expenses can pile up quickly. When their check from the at-fault party arrives, victims can catch up financially and begin reconstructing their lives. 

However, one thing that personal injury victims may wonder about is taxation. Specifically, are personal injury settlements taxable, and should you report them on your tax return? The answer is a bit complex. The IRS taxes personal injury settlements and awards based on several factors, including the category they fall into and whether you claimed exemptions in a prior tax year. 

Since tax laws can be very complicated and often change, it’s best to seek individualized advice from an attorney concerning any settlement you receive. Cooper Hurley Injury Lawyers can help you figure out whether you’ll owe taxes on your settlement and what to include in your return.

Do You Pay Taxes on Personal Injury Settlements?

In most cases, you will not owe taxes on compensation you receive for personal injuries. However, the IRS breaks your settlement into taxable and nontaxable categories. If the money you receive falls into specific buckets, you may need to declare it as income and pay taxes accordingly. Some types of compensation that are subject to tax include lost wages, punitive damages, and interest.

Types of Damages in Personal Injury Cases

Generally, personal injury settlements and award verdicts contain a mix of compensation types. You might receive damages for past and future medical expenses, lost wages, emotional distress, and property damages. Other potential compensation includes punitive damages and even interest.  

So, are personal injury settlements taxable in Virginia? Here is how taxes affect each compensation category.

Medical Expenses

Medical compensation includes damages for past, present, and future medical expenses. Examples include hospitalization, follow-up visits, physical therapy, medication, and any other medical care you receive due to your injury.  

Generally, you will not owe any taxes on compensation you receive for medical expenses. That means you can keep the money you receive and use it to pay your outstanding medical bills and future care costs.  

However, there is a caveat. If you claimed a medical expense deduction related to your personal injury in a prior year’s tax return, you must report the deducted amount on your current tax return and report the tax benefit you received as “other income.”

Pain and Suffering

The pain and suffering you endured following an accident cannot be directly calculated using medical bills or income statements. That is because pain and suffering damages are subjective in nature and will vary depending on the severity of your injuries and other factors.  

From a tax perspective, pain and suffering expenses usually are not taxable either. However, you must report them if they do not originate from a personal injury or illness. You can reduce the amount you report by deducting medical expenses related to emotional distress or mental anguish from your injury that (1) you did not previously deduct or (2) you previously deducted but that did not provide a tax benefit.

Lost Wages

If your personal injury prevents you from doing your job, you may receive compensation for lost wages. Generally, lost wages can include back pay, future earnings, or severance. If these damages are obtained as part of a personal injury settlement, they are generally not taxable. However, if it is part of an employment-related lawsuit, such as a wrongful termination claim, damages for lost wages are taxable.

Punitive Damages

A court may award you punitive damages as punishment for defendants when their extreme irresponsibility leads to injuries. The purpose of punitive damages isn’t to reimburse you for your losses but to deter individuals from engaging in the behavior that gave rise to your case. The IRS explains that punitive damages are taxable except when “awarded for wrongful death, where under state law, the state statute provides only for punitive damages in wrongful death claims.”

Property Loss

Sometimes, an accident may result in property damage or loss. Generally, you will not owe taxes on property damage awards unless the income you receive is more than your adjusted basis of the property. However, if your settlement for property loss exceeds its adjusted basis, you will need to refer to the rules on capital gains and losses set forth by the IRS.  

For example, assume you are in a car wreck, and the insurance company declares your vehicle a total loss. At the time of the wreck, your car is worth $10,000. However, the settlement you receive includes $8,000 as property loss compensation. You would not need to include it as taxable income since it is less than the adjusted basis of your car.

Interest

Occasionally, settlements include interest. Any such interest is considered “interest income” by the IRS and should be reported on your tax return.

Trust an Experienced Personal Injury Lawyer With Questions About Your Settlement

Understandably, you may have lots of questions after an accident, including whether your settlement will be taxed or not. We are here to address your questions and concerns in a free consultation. When you work with us, you can rest assured that your case will be handled with utmost care and attention.  

Our legal team has recovered millions of dollars in verdicts and settlements for injury victims throughout Virginia and beyond. We have what it takes to hold at-fault parties accountable when their actions lead to accidents and injuries. Let us put our decades of combined experience to work for you. Contact us today to schedule your free, no-obligation consultation.

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