Do I Have To Pay Tax On My Personal Injury Settlement?
Most people who receive a settlement for personal injuries do not have to pay income tax on the proceeds. The main issue is the specific types of damages you suffered and for which you are compensated. The IRS has provided the following general rules.
Pain and Suffering
Compensation for pain and suffering is often a large part of a settlement. Money compensating you for emotional distress, pain and suffering, or mental anguish caused by a personal injury is non-taxable. Because these settlement proceeds are not taxed, they should not be reported to the IRS as income.
Medical care is expensive, and serious accidents can lead to serious medical bills. Thankfully, money compensating you for medical expenses caused by the accident are usually non-taxable and not reported as income. The only exception is if you took an itemized deduction for medical expenses on your taxes in the years prior to the settlement. If you did deduct the medical expenses prior to settlement, then you must report any benefit you received from this deduction as “Other Income” on line 21 of Form 1040. Consult a tax professional to ensure proper reporting.
Injured people cannot work. Many settlements contain funds to compensate you for wages you lost out on while you were too hurt to work. The IRS characterizes the lost wages portion of the settlement as taxable wages that are subject to Social Security and Medicare withholdings. In short, there is a lot of tax owed on a settlement for lost wages. Accordingly, most personal injury settlements do not specifically state that they are compensating an injured person for lost wages.
What if the other side does not settle and you have to go to trial? In Colorado, if you go to trial and receive a judgment to compensate you for your injuries, then you will be awarded 9% compounding interest from the date of your injury. Because trial usually occurs years after the injury, this can be a huge number. Sadly, interest awarded after trial on your personal injury claim is taxable and should be reported to the IRS.
The following is a quick summary:
- Money compensating you for pain and suffering is not taxed.
- Money reimbursing you for medical expenses is not taxed unless you previously took an itemized deduction on your taxes.
- Money compensating you for lost wages is taxed.
- Interest awarded on a personal injury judgment after trial is taxed.
Recovering from an accident is hard. It is even harder with a large tax bill. Work with your attorney and tax professional to properly report and structure your settlement. This will keep more money in your pocket.