If you have received a personal injury settlement or judgement, it is important to understand what you can and cannot deduct, and what is and is not taxable. After all, you are entitled to several different types of compensation after the accident, such as for medical bills, pain and suffering, lost wages and interest accrued on the award. Below is more information. Be sure to talk to a tax professional about your specific settlement or judgement to ensure you are following all applicable tax laws.
Money For Medical Expenses
Money that is paid to you for your medical costs stemming from treatments for your accident injuries are free of taxes. But if you claimed a tax deduction for medical expenses related to the accident, and you are reimbursed later for these medical expenses as part of the case, it is required that you recapture this money and you will need to pay taxes on it because you benefited from the deduction that you took before. If the settlement does not give an amount for medical costs and you took a tax deduction for medical expenses, the settlement is considered a reimbursement for these expenses.
So, the key matter here is the tax deduction. If you did not take the deduction for the medical expenses, then the award is free of tax. If you did benefit from taking a tax deduction, you have to report these amounts on your tax return after you get your settlement.
Interest Paid on the Settlement Award
Interest is not usually part of your settlement, but it might be part of your award if there is an appeal. Just remember that any part of the settlement or award that is considered interest is taxable as income.
Reimbursement for Lost Earnings
Generally, the amount that you are paid for lost wages are free of federal taxes, even though the wages would have been taxed if you had gotten them through work.
Money for Pain and Suffering
There always are questions about the compensation you receive for pain and suffering. This is the money tat you are being paid to you for your physical suffering. As long as this compensation is for an actual physical injury, it is paid to you free of taxes. But if you are being compensated for mental pain and suffering only that is not related to a physical injury at all, this compensation will be considered taxable as income.
One thing is always for certain on settlements and judgements for personal injury cases: If you receive compensation for punitive damages that are intended to punish the defendant for their behavior, this will always be taxable as income.
It is important to have your personal injury settlement or judgement case reviewed by a qualified tax professional to ensure that you are obeying all relevant tax laws. It is common for people to get an unpleasant tax bill the year after their settlement or judgement. This can be a very stressful situation that can be avoided by proper tax advice.