• March 13, 2019
• CMZ Law
• no comments

The IRS defines income as any money, property, or services that you receive. Generally, all income is taxable unless it is specifically exempt by law. Technically speaking, personal injury settlements are income based on the IRS’s definition. This is true despite the fact that personal injury settlements are often used to compensate you after an accident. Even so, the IRS makes certain exceptions for portions of personal injury settlements.

Depending on what your settlement is for, portions of it may be taxable. It is important to consider itemizing your compensation arrangement for tax purposes.

Compensation Related to Physical Injuries

Not all personal injury cases involve injuries to the body, but many do. If your settlement or award for your personal injury case is based on physical injuries or illness, and you did not take an itemized deduction for your medical expenses related to that injury, you do not need to include the settlement proceeds as part of your income.

However, if you took an itemized deduction, you cannot also claim that the settlement income is exempt. Whatever portion of the settlement is for medical expenses that you deducted in prior years should be included in your regular income. It will be reported as “other income.”

Compensation for a Mental Anguish or Emotional Distress

If your mental anguish or emotional distress is specifically caused by a personal physical injury or sickness, then any award for this type of damage is treated the same as physical injury compensation. If, however, the emotional anguish is not related to physical harm, then it should be included in your income. For example, if your mental anguish is related to someone else’s injury, it would likely be taxable. Nonetheless, you can still deduct any amounts paid for medical expenses not previously deducted from the taxable settlement portion.

Taxation on Lost Wages or Lost Profits

Any amount that you receive for lost wages or lost profits will be taxed as if you earned it while working. This means that not only are federal taxes due on the settlement, but it is also subject to Social Security and Medicare obligations as well. In fact, you report this portion of the agreement as regular wages on line seven of Form 1040.

Lost profits are treated similarly. Assuming the lost profits are related to your trade or business, you should include the income as if you earned it on your Schedule C. That also means that a portion of the settlement is subject to the self-employment tax as well.

Other Taxable Portions of Settlements

You may also be taxed on compensation for reimbursement for property damage. However, whether you owe tax will depend on the adjusted tax basis of the property. These situations can be tricky, so you may want to work with a tax professional or an attorney to deal with these issues.

Any interest that you receive on your settlement is taxable as interest income. Many people overlook interest, but it can be a valuable part of your settlement if there is a delay in payment.

Punitive damages are fully taxable, even if you receive them in relation to your physical injuries or sickness.

Your personal injury attorney can help you work through the tax implications of your settlement or award. Contact our team to discuss your personal injury case and how a settlement may impact you.