When you are injured in an accident caused by someone else, you may be able to recover compensation for your injuries. Most personal injury claims are resolved without going to court by the defendant or their insurance company paying an agreed-upon amount of damages.
But when you’ve receive your settlement, you may wonder: Do you need to pay taxes on the money you collected?
In most cases, your settlement proceeds are not taxable. However, depending on the purpose of the settlement proceeds, some may be taxable. According to the IRS, the key question is: “What was the settlement (and its corresponding payments) intended to replace?”
If you have received a personal injury settlement, you need to understand the basics of the different types of settlements and know when to consult a tax advisor. How your settlement proceeds are categorized in your settlement agreement is important. You need the assistance of an experienced Lafayette personal injury attorney to help ensure your settlement agreement accurately categorizes your proceeds.
When Are Settlement Proceeds Taxable?
Section 61 of the Internal Revenue Code states that all income from any source is taxable and included in gross income unless a specific exception exists. Thus, unless your settlement proceeds fall under an exception—which is often the case, as we will cover shortly—your settlement proceeds are indeed taxable.
Categories of Settlement Proceeds
Settlement proceeds can generally be divided into three categories:
- Actual damages for physical and non-physical injury.
- Emotional damages caused by the actual physical or non-physical injury.
- Punitive damages to deter or punish unlawful behavior.
Proceeds received for physical injuries are generally not included as taxable income. When settlement proceeds are received for emotional and mental distress arising from non-physical injuries, they are excluded from gross income for tax purposes only if they are received in compensation for a physical injury or physical sickness.
Punitive damages are taxable in most (but not all) cases.
IRS Provisions Applicable to Personal Injury Settlements
While all income is taxable, IRC Section 104 provides an exception for income received as damages due to physical injuries. Specifically, Section 104 (a)(2) allows taxpayers to exclude from their 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 injuries or physical sickness.”
You may be wondering what exactly qualifies as damages received on account of personal injuries or physical sickness. Regulation Section 1.104-1(c) states that damages received for personal physical injuries or physical sickness means any amount other than workers’ compensation received through the prosecution of a legal suit, action, or settlement agreement entered into in lieu of prosecution.
In most cases, punitive damages are not excluded from gross income, making them taxable. Yet, IRC Section 1.104(c) provides another exception, stating:
“The phrase ‘(other than punitive damages)’ shall not apply to punitive damages awarded in a civil action—
(1) which is a wrongful death action, and
(2) with respect to which applicable State law (as in effect on September 13, 1995 and without regard to any modification after such date) provides, or has been construed to provided by a court of competent jurisdiction pursuant to a decision issued on or before September 13, 1995, that only punitive damages may be awarded in such an action.”
In other words, most settlement proceeds are not taxable—but whether your settlement is taxable depends on the specific facts of your case and how your settlement is classified in the settlement agreement. You need the assistance of an experienced personal injury attorney to help ensure your proceeds are exempt from taxation whenever possible and to advise you when you need to seek further tax advice.
Contact Anderson Blanda & Saltzman Today
If you have been injured or lost a loved one in an accident caused by another party, you may be entitled to recover compensation for your damages. Insurance companies and defense attorneys work hard to deny your claim, shift blame, and settle your case for as little as possible. You need the assistance of an experienced Louisiana personal injury attorney to help you recover the full compensation you deserve.
At Anderson Blanda & Saltzman, we have the experience, skills, and resources to protect your rights and help you recover maximum compensation. Schedule a free consultation to discuss your personal injury claim. We will listen to you, answer your questions, and explain your rights and obligations—including any potential tax implications for your settlement.