In some cases, yes, personal injury settlements are taxable. This is a common concern among our clients. And it's only one of many. Between following all of the steps to file a claim or lawsuit, preparing for negotiations or court, and navigating the claims process within the confines of Pennsylvania personal injury laws, it can be very confusing.
Now add taxes into the fold and things become even more confusing. The taxability of your settlement is a detail of which you need to be aware so that you don’t run into problems come tax time.
The Taxability of Personal Injury Settlements
Whether or not your settlement funds are taxable depends on the types of damages for which you received compensation. Most of your settlement will be not be subject to taxes, but a portion of it might be.
Most compensation you receive from a personal injury claim is non-taxable. So long as your tort is based on a physical injury (not other legal injuries such as economic or reputational injuries), most of your funds will be sheltered from taxes. This includes damages for medical bills and pain and suffering. “If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable,” provides the IRS.
A personal injury settlement may be taxable under the following circumstances.
- Lost wages – If you received damages for lost wages, then that portion of your settlement is subject to taxes.
- Pain and suffering for wrongful death – If you received damages for any pain and suffering in a wrongful death claim, then those damages are taxable to the estate.
- Emotional injuries – If your settlement is for emotional, and not physical, injuries, then the settlement is taxable.
- Punitive damages – Punitive damages are awarded to victims as means to punish the wrongdoer and discourage future negligence. Because these types of damages are not meant to reimburse for actual harms, they are considered extra income, and are taxable as such. You’ll need to report punitive damages on in the “other income” section of your tax returns.
- Confidential settlement – If the settlement is confidential, it could be subject to taxes.
IRC § 104(a)(2) provides that you can exclude the following from your gross income: “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.” So, as long as you filed your claim “on account of personal injuries…” your settlement (minus punitive damages) will be tax-exempt.
Determining How Much Money to Set Aside for Taxes
If you will owe taxes on a portion of your settlement, you’ll need to set aside those funds until it’s time to pay your taxes. The insurance company (or whichever party writes your settlement check) will not withhold those taxes for you.
You’ll need to know what tax bracket you are in to determine how much to set aside. Most people fall between the 15 percent and 28 percent tax bracket. A good rule of thumb is to set aside roughly a third of your taxable damages to cover your bases. You can speak to your attorney or an accountant for more specifics.
Health Insurance Liens on Injury Settlements
It’s important to mention that although you may not owe taxes on most of your personal injury settlement, you might owe your health insurance company some of it. If you had to use your own health insurance to pay for your medical bills while awaiting your personal injury settlement check to come arrive, your health insurance company may take part of your settlement through subrogation.
How a Personal Injury Lawyer Can Benefit Your Case
Taxes on your settlement are a thorny aspect of personal injury claims. The laws are complex and the fine print is sometimes unclear. While you should consult your accountant about tax issues, your attorney can give you basic information about the taxability of your settlement.
The biggest benefits of hiring an attorney are handling the legal steps necessary to file your claim, presenting a solid case, and ensuring that you account for all of your damages. Once you have a clear picture of the damages you deserve, you can start considering taxes. Your attorney can even answer any questions you have about how all of this ties together.
If you need a lawyer in Bucks County, Pennsylvania, call Saile & Saile LLP. Our legal team knows that the value of your case goes far beyond the hard and fast figures, such as hospital bills and lost wages. While these are two very important factors in the formula, there are others to consider as well, which is where a good injury lawyer is most beneficial. Contact us today at 215-486-8196 to schedule a free consultation.