In the vast majority of personal injury cases, the settlement award is not taxable at the federal or state level.
No Taxing Of Personal Injury Cases (In Most Cases)
The IRS will not tax you on any monies you received as compensatory damages in a settlement or a verdict of a personal injury lawsuit involving physical injury or physical sickness.
This exemption extends to personal injury damages as well. Damages can include medical bills, emotional distress, pain, suffering, attorney's fees, and loss of consortium, as long as those damages are tied directly to a physical injury or sickness.
Texas does not have personal income taxes and does not tax personal injury settlements or verdicts.
Exceptions To The Rule
As with all federal tax laws, there are exceptions to the rule. Settlements or verdict awards from breach of contract lawsuits that involve personal injuries are subject to taxation by the IRS. This is true even if the claims are filed separately.
Also, you are only entitled to recover the net after-tax amount of your lost wage claim. In other words, you are not entitled to the gross recovery of your lost wages claim, but the net recovery after taxes.
Punitive damages are always taxable. Punitive damages are those damages awarded to the plaintiff as a punishment to the defendant. These kinds of damages are usually awarded separately from compensatory damages. This makes it easy to separate what is taxable and what is non-taxable.
Courts often award interest on monies gained in a settlement or verdict. The interest usually starts from the date the lawsuit was filed and ends on the date the defendant makes full payment. Any monies received as interest is reportable as interest income.
Any settlements or verdicts you receive as a result of purely emotional damage is taxable. However, if the emotional damage is tied in any way to a physical injury or physical sickness, it is non-taxable.
If you deducted (in previous years) any part of your medical expenses that were a result of the personal injury claim, that part of the settlement must be reported as taxable income.
Ensuring Your Settlement Or Verdict Is Non-taxable
In some lawsuits, there may be two or more claims made against the defendant, only one of which is personal injury. If that is the case, any settlement or verdict you receive should separate out the damages being paid for each claim, instead of as a lump sum. This limits the chances of the IRS coming back and trying to tax the entire amount instead of just the non-personal injury parts.
If you need assistance with a personal injury lawsuit, contact us here at Stockard, Johnston, Brown & Netardus, P. C.. Our Personal Injury team can help you file suit, obtain settlement, and take your claim to trial if necessary. Call and set an appointment today.