You’ve been hurt in a motor vehicle accident or in a slip and fall on someone else’s property. You’re considering accepting a settlement to cover your losses or a jury has awarded you damages. Will the settlement or verdict be subject to income taxes? Maybe yes and maybe no. Let’s take a closer look.
When determining whether a personal injury settlement or jury verdict is potentially taxable, the key question to be asked is “what is the damage award intended to replace?” In a personal injury lawsuit, you can seek damages for:
According to the Internal Revenue Code, any compensation that a person receives for physical injury or illness is not subject to taxation, whether it’s in the form of a settlement or a verdict. Furthermore, if your losses are related to a physical injury, they will not be taxable. Therefore, any compensation for the losses specified above, if related to a physical injury, will not be subject to taxation. Compensation for lost wages, loss of companionship, medical expenses, pain and suffering, and loss of enjoyment of life, if stemming from a physical injury, will not be taxable.
As a general rule, compensation for wholly emotional injuries will be taxable, unless you can show that the emotional distress was caused by a physical injury. For example, if you suffered permanent scarring and disfigurement in a car accident, which caused you embarrassment or humiliation, it may be non-taxable.
Because punitive damages are not intended to compensate you for any loss, but rather to punish the wrongdoer, they will typically be subject to income tax.
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