The Internal Revenue Service is a much-feared organization, unfortunately. People look on tax season with trepidation, in many cases. For that reason, it is no surprise that among the first questions asked by many new personal injury clients is the inquiry into whether or not they will be expected to pay taxes on the compensation paid by negligent parties.
A settlement being paid after a personal injury lawsuit should be a reason to celebrate, as the tragic events finally come to a sort of culmination. However, it can also be scary for those who have never been through the circumstances before and the IRS has not made it any easier for those individuals to find comfort with wording like this, found under §1.104-1 Compensation for Injuries or Sickness:
Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from 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 physical injuries or physical sickness. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.
Making sense of this is not a task that most St. Petersburg citizens would find joy in. Fortunately, well-trained personal injury attorneys have dealt with enough cases that they can provide the answers needed regarding taxation.
In general, the majority of winnings in a personal injury case are awarded as compensatory or general damages, which is to say that they are meant to recoup the monies paid out as a result of the defendant’s negligence. As a result of which, most will not be taxed.
What will be taxed? Below is a list of some of the funds that could be taxed:
- 1. Compensatory damages meant to cover expenses that were used as tax write-offs on previous year’s returns. That is to say that, if you included your medical expenses as a deduction on a tax return in the past, the compensation meant to cover those expenses could be considered taxable now.
- 2. Damages paid to cover lost wages. Very often, after accidents, which leave the victim seriously injured or permanently disabled, the court will award monetary damages meant to repay the wages lost as a result of that person being unable to work. These funds could be applied to past lost wages or as compensation for wages that will not be earned in the future, as a result of the injuries. Your earnings would have been taxed when paid to you, so monies awarded in an effort to recoup those lost earnings will also count as taxable income.
- 3. Punitive damages, which are awarded in extraordinary cases, in an effort to punish the defendant for some gross negligence, are generally taxed.
Though this will provide a partial answer to your questions, chances are good that you will need some assistance determining which percentage of your settlement monies are taxable. Your Saint Petersburg attorney should be able to assist with this task. It is also wise to consult with a Certified Public Accountant after winning damages in a personal injury case to ensure that IRS expectations are clearly understood.