If you are involved in a personal injury lawsuit, you probably have a lot of questions about what will happen if your case is settled, including if your settlement is taxable. You may have heard about people receiving large sums in personal injury settlements but wonder how much they really get to keep. Our brief guide to personal injury settlements and taxes will help you get an idea of what to expect.
According to the IRS, you do not have to pay federal taxes on a settlement related to personal injury except under specific circumstances. The purpose of a personal injury settlement or judgment is to compensate you for expenses and loss of income you would not have had if the injury had not occurred. So in general, settlements for physical injuries or illnesses are not considered “income” for tax purposes. Of course, there are caveats and exceptions, which we will discuss below.
Previous Medical Deductions
If your injury occurred some time ago, you may have taken an itemized tax deduction for medical expenses related to the injury on one or more of your previous tax returns. If this is the case, then a portion of your settlement may be taxable in relation to those deductions “to the extent the deduction(s) provided a tax benefit.” Figuring out these amounts may be complicated, especially if you took these deductions in multiple years. You will probably want to contact an accountant if you find yourself in this situation.
Pain and Suffering
A portion of your settlement may be awarded for “pain and suffering” or emotional damages arising from your injury. This amount will be considered taxable or non-taxable according to the same rules applied to your compensable damages as outlined above.
However, if your lawsuit is related to emotional injury or distress only, and does not involve a physical injury, the settlement will generally be considered taxable income.
Punitive damages, if they are included, are usually awarded as part of a judgment if your case goes to trial. Punitive damages are always considered taxable income, since it is an additional amount above and beyond what is considered fair to restore your losses. The rest of your judgment, known as compensatory damages, will follow the same tax rules as an out-of-court settlement.
Any interest earned from your settlement is also considered taxable income. For example, if you place all or part of your settlement amount in a savings account that earns interest, that interest will be taxable, just as other types of earned interest are taxable. Don’t hesitate to deposit your settlement into interest-bearing accounts, however, as the original settlement amount is still not taxable (with exceptions as listed above).
Health Insurance Marketplace
If you or someone in your household is enrolled in a health insurance plan through the Health Insurance Marketplace and you receive a tax credit for some or all of your premium, you may need to contact the Marketplace about your settlement. You only need to do this if a portion of your settlement is taxable under any of the circumstances described above. If your whole settlement is non-taxable, then it will not change your income for tax purposes, and thus will not affect your Marketplace coverage or tax credits.
Virginia State Taxes
Regarding Virginia state income tax, there are no additional elaborate calculations needed. Given the guidelines above, if any portion of your settlement is considered taxable on your federal tax return, it will also be taxable income for your state return. If part or all of your settlement is non-taxable for federal purposes, then it will also be non-taxable for your state taxes.
Getting the Most of Your Settlement
It is important to consider potential taxes when negotiating your settlement. Especially in the case of larger settlements, the way the settlement is structured can make a big difference in how much tax you may need to pay. Be sure to discuss this with your attorney before finalizing any settlement agreement. An experienced attorney will know how to maximize the amount that goes in your pocket.
If you have been injured, you need an experienced injury attorney on your side who can manage all the details of your case, including tax considerations. Contact Geoff McDonald & Associates for a free consultation at (866) 369-9051 or through our website.