You’ve dealt with surprise after surprise following your personal injury claim. From the shock of the injury itself to the unwelcome news that an insurance company is trying to deny your claim and the major expenses involved in medical care, you couldn’t have imagined how stressful the situation could be. But now you’ve settled, and it’s time to move on. Or is it? There may be another unfortunate surprise in store for you at tax time. Are personal injury settlements taxable? The short answer is another unwelcome surprise: it depends.
Avoid headaches and financial difficulties this tax season. Read on to find out how and if your personal injury settlement will be considered taxable.
What Exactly is a Personal Injury Settlement?
Before we dive into the tax implications of a personal injury settlement, let’s take a deeper look at what is covered under the term.
You may be familiar with the terms “bodily injury” and “personal injury.” While both are used to describe physical injuries, bodily injury is most frequently used to describe injuries arising from an assault or other criminal action, but it is also a term used in car insurance policies. It refers to actual injuries to the victim’s body such as broken bones, burns, and lacerations. Bodily injury claims are more limited in scope than personal injury claims.
Personal injury claims, by contrast, cover a wider scope of injuries and compensation. Among other things, these claims cover property damages, lost wages, pain and suffering, and medical bills. This term includes injuries from a wide variety of sources.
Here are the most common types of personal injury claims.
A workplace accident, or workers’ compensation claim, is any injury that occurs on the job site or while performing your duties at work. To be eligible for this type of settlement, the claimant must prove that the injury occurred on the job and was not caused by employee negligence. Settlements in these cases are frequently decided following a review of workplace safety regulations, training, and common sense employer practices. If the employee is not found to be culpable for their injury, a settlement will be issued to cover lost wages, medical bills, and, if appropriate, pain and suffering.
Sometimes known as a “slip and fall” injury, a claim can be filed against a homeowner if an injury occurs on their property. This can include missing railings, holes, cracked and uneven sidewalks, animal bites, falling debris, and other property issues that contribute to an injury. Because pet owners have a responsibility to safely contain their animals, a claim for an animal-related injury can be filed even if the victim wasn’t on the property, such as with a loose dog or roaming livestock.
Losses and injuries resulting from vehicular collisions are, by far, the most common type of personal injury claim. These settlements include physical injury and medical bills as well as property damages and, if appropriate, pain and suffering. Lost wages and rehabilitation costs can be included in these settlements as well. It’s usually necessary to prove the other party was at fault, but it may be possible to pursue a lawsuit if extenuating factors contributed to the accident.
Defective product liability
Manufacturers must produce safe products for consumers. If their products result in injury, either acute or long-term, the manufacturer can be sued. Some very high-profile product liability cases include the infamous McDonald’s hot coffee incident, resulting in an undisclosed amount awarded in a personal injury settlement, and the class-action lawsuit against Toyota in 2010 after the cars were found to have “sticky” accelerator pedals. Other notable cases are Roundup Weed Killer, found to contain carcinogens, and Johnson & Johnson’s talc products, which allegedly showed traces of asbestos.
Of all personal injury claims, those involving medical malpractice may be the most devastating. When a trusted physician makes a mistake or an error in judgment, the consequences are life-altering and may even lead to wrongful death. These injuries arise from any number of contributing factors, including:
- Delay of treatment
- Understaffing of medical facilities
- Surgical errors
- Facility-acquired infections
- Medication and dosage errors
- Diagnostic errors
Per a study released by the NIH National Library of Medicine, it is estimated that more than 250,000 deaths per year may be attributed to medical malpractice.
Are Personal Injury Settlements Taxable?
Some personal injury settlements are taxable, and some are not. It depends largely on the types of damages awarded and any tax deductions you’ve claimed concerning the settlement. Insurance companies will submit a 1099 tax form to the IRS to report the amount of your award for your personal injury claim.
Federal tax law 26 USC 104 covers these claims, so let’s take a closer look at some of the factors considered as a tax liability for your award.
Previously deducted medical expenses
Personal injury claims may take quite a while to settle, and you may have to pay out-of-pocket for treatment while awaiting a payout. If you claimed these expenses in a previous year’s taxes, you may be required to consider those write-offs as income the following year after a settlement is reached.
Worker’s compensation claims
As a rule, settlements involving a worker’s compensation claim are not taxed. If you return to work in a different capacity following your injury, however, those wages will still be considered taxable. Any survivor settlements are generally considered tax-free.
Pain and suffering
While an “official diagnosis” of pain and suffering doesn’t exist, if emotional distress is linked to an injury, the award is not taxable. If it is unclear that distress is linked to the injuries sustained from the incident, this portion of a personal injury settlement may be considered taxable. This gets tricky, however, as some personal injury claims (such as discrimination or a damaged reputation) aren’t the direct result of a physical injury. In these cases, the personal injury settlement itself may be taxable, but the treatment for the emotional distress will not.
Regardless of the tax liability in a personal injury settlement, the out-of-pocket attorney fees occurring during the process are usually tax-deductible. If, however, those fees are included in the award they will be taxed as income if you’ve already claimed them as expenses.
Recovered wages are still considered wages and are taxable. If your personal injury settlement includes an award for lost wages, you will be required to report this amount as wages for taxation purposes.
Other portions of your settlement will be taxable, including any interest paid on the award and any amount received for punitive damages. Punitive damages aren’t usually a part of a personal injury claim, however, and are a legal way of “punishing” a corporation for negligence, such as the class action lawsuit involving the Round-Up Weed Killer example noted above.
Awards for non-injury-related matters, such as breach of contract, will be considered taxable as well.
Play it Safe
Most personal injury settlements are paid out as one lump sum, making it nearly impossible to separate taxable portions from the non-taxable. Your best bet is to play it safe and turn your taxes over to a tax attorney, accountant, or other tax expert and let them file on your behalf. Failure to properly report taxes, even if you were not aware of your tax liability, will result in fines and penalties from the IRS.