Are Personal Injury Settlements Taxable?
Taxes are always tricky and can get even more confusing after an accident. Are personal injury settlements taxable? Adding a personal injury settlement to your yearly income might leave you short on money. Some settlements are big enough to move you into a higher tax bracket, meaning you might pay more taxes.
However, your taxes don't have to be a huge problem. The IRS doesn't have to scare you. Whether you're still dealing with a lawsuit or have already settled your claim, our personal injury attorney can help you understand your finances after the case.
What Does the IRS Say?
When figuring out how a settlement affects your taxes, the IRS is the best source of information. The IRS explains settlement taxability in Publication 4345. This document shows which parts of your settlement are taxable, which are not, and any exceptions.
The 2017 Tax Cut and Jobs Act changed tax rules on personal injury settlements. According to this act, you must include the entire compensation amount in your year-end income before deducting attorney's fees.
Unfortunately, this act can put financial pressure on people who receive settlements. You can discuss how contingency fees and the settlement's taxability affect your case with an attorney. Together, we can find the best way to protect the financial support you worked hard to get.
Your Taxable Settlement Income
Depending on the circumstances of your case, some parts of your settlement might be taxed by the federal and state governments. It's important to know which parts of your settlement are taxable so you can prepare your year-end returns (and your bank account) accordingly.
Pain and Suffering Without Injury
Your settlement will likely be taxable if you got money for feeling bad without getting hurt or sick before you sued. Including these non-economic damages in your year-end income is important in such cases. This will ensure you comply with tax laws and avoid any penalties. While preparing your taxes, discussing your situation with an accountant is also advisable. They can help you understand which deductions you might be eligible for and guide you on minimizing your tax liability. Proper planning and professional advice can make a significant difference in managing your finances after receiving a settlement for pain and suffering without physical injury.
Lost Wages and Back Pay
If you receive compensation equivalent to back pay in a settlement, it's important to know that this payment may be subject to taxes. You may need assistance from a third party to accurately calculate and manage the taxes on this back pay, ensuring compliance with IRS regulations and avoiding potential issues.
Understanding Punitive Damages
In a personal injury case, you can't directly request punitive damages when going to court. Instead, a judge might decide to include punitive damages in your case, especially if there's evidence of gross negligence or recklessness.
Although punitive damages can increase your settlement amount, they are subject to taxes. You'll have to report punitive damages as part of your income when the year ends. This applies regardless of whether or not you were physically injured by the incident that led to your case.
Understanding Deducted Expenses
Personal injury claims can often extend beyond a year. During the duration of your case, you have the opportunity to include accident-related expenses, like medical bills, as deductions. However, after you've received your settlement, you might be required to reimburse expenses previously deducted.
Understanding Your Non-Taxable Settlement Income
If you've experienced physical injury, illness, or a similar condition due to an accident, you typically don't have to pay taxes on your personal injury settlement. Specifically, the compensatory nature of these damages allows you to exclude the following from your year-end income:
- Medical expenses
- Property repairs or replacement
- Legal fees related to your case
- Reduced quality of life
- Emotional distress
- Loss of consortium
While physical injuries can make your year-end taxes more manageable, ensuring you're on the right side of the law is crucial. Consulting with a personal injury attorney is highly recommended if you need clarification on whether your settlement falls within the compensatory category. Both attorneys and accountants can offer essential assistance to help you adhere to IRS regulations.
Exploring Other Non-Taxable Settlements
Similarly, specific personal injury settlements remain non-taxable, irrespective of whether the individual suffered a physical injury. These include:
Understanding Wrongful Death Settlements
Wrongful death lawsuits initiated by a personal representative indicate a significant tragedy within a family. Taking into account the injuries suffered by the deceased and the enduring pain of the family,
Wrongful death settlements are generally exempt from federal or state taxes, meaning they are not usually subject to taxation at either level.
However, it's important to note that if a judge decides to grant punitive damages to the family following a wrongful death, the tax scenario may change. As mentioned earlier, punitive damages are always taxable. While you can deduct compensatory damages from your year-end income, it's crucial to collaborate with a wrongful death attorney to ensure proper accounting for these additional damages.
Workers’ Compensation
Additionally, the federal government offers a tax exemption for specific types of workers’ compensation. It’s important to ascertain if your case qualifies for this exemption before the tax season begins.
If your case involves a work-related illness, injury, and/or related medical expenses, you are not required to report your workers’ compensation settlement as part of your yearly income. Furthermore, the case's retirement benefits or interest will remain tax-free.
Understanding the IRS's Percentage of Claim
The portion of your settlement that the IRS claims corresponds with your tax bracket. When April of the following year arrives, you will incorporate the settlement into your total income. Subsequently, depending on the tax bracket you fall into, you will reimburse a percentage of your income to federal and state authorities using standard forms.
For instance, let's imagine you typically earn around $45,000 annually. In the year you receive a $200,000 settlement, you'll need to include this amount in your total income, making it $245,000. Consequently, you'll be subject to a 35% tax rate instead of your usual 22%.
If you seek more details regarding your fluctuating tax bracket, you can seek assistance from an attorney or utilize one of the many tax bracket calculators available today.
Personal Injury Settlements and Your Health Insurance
The level of assistance you receive for healthcare expenses under the Affordable Care Act depends on your annual income. When you apply for this aid, you must estimate your income. You might owe additional taxes the following year if you underestimate your income because you've received a settlement offer.
You can adjust your estimated income if you receive a personal injury settlement. Visit healthcare.gov and report a change in circumstances. The federal government can modify your monthly premiums to help you avoid tax penalties.
However, if you cannot adjust your income in time, there's no need to panic. Although you'll need to repay a portion of your subsidized premium, the Affordable Care Act limits the maximum amount you can be charged to 8.5% of your total household income.
Seek Assistance from a Personal Injury Lawyer
As you file your tax forms this year, you must ensure you've met all your financial responsibilities to state and federal authorities. Consulting a personal injury lawyer can prove beneficial if you've obtained a personal injury settlement during the previous tax year. They can petition a judge to differentiate between compensatory and punitive damages, simplifying your tax filing process.
For expert legal guidance and assistance, reach out to The Law Offices of Clinton O. Middleton Contact: 703-777-9630
