It’s that time of year again—tax time. As lawyers who help injured victims get compensation for their injuries, we are often asked whether settlement awards are taxable. Although we cannot give tax advice, we hope that this general overview is helpful.
Personal Injury Awards and Settlements Are Generally Not Taxable
Whether your settlement or damages award is taxable depends on the nature of your case and why you received payment. In most cases, personal injury settlements are not taxable. Contrast the tax consequences for non-personal injury awards, such as awards for employment discrimination, breach of contract, or trademark infringement, where any award is usually taxable as ordinary income. Any money you receive from a personal injury claim, however, is considered “compensatory,” meaning it is meant to compensate you for your loss and “make you whole again.” The rationale behind not taxing these awards is that if this money were taxed, you would not truly be made whole again by the damages award.
26 U.S. Code § 104 (of the Internal Revenue Code) addresses “compensation for injuries or sickness,” and 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[.]” Generally speaking, you do not need to pay taxes on money from a personal injury settlement or jury award meant to compensate you for:
- Physical injuries (and associated medical bills)
- Emotional distress caused by physical injuries
- Lost wages that result from physical injuries
There are many exceptions to this rule, and if you have questions about your particular situation, we advise that you speak with an accountant. Depending on the nature of your award and what decisions you made when filing your taxes in previous years, you could still owe the IRS.
First, if you already received a tax benefit in a prior tax year relating to your case, you cannot take advantage of additional tax benefits. For example, if you deducted your out-of-pocket medical expenses stemming from your accident in your tax return from last year, you must now pay back the IRS for the deduction. The amount is considered “other income” and must be reported.
Additionally, any interest earned on a personal injury award is taxable. This should be reported to the IRS as “interest income.”
Punitive damages can also be taxed in many situations. Punitive damages differ from compensatory damages. Whereas compensatory damages are intended to make a victim “whole again,” punitive damages are intended to punish a wrongdoer. Failing to report a punitive damage award on your taxes can result in steep penalties from the IRS. Punitive damages should be reported on your 1040 as “other income.”
If someone’s negligent conduct has cause you to suffer injury, the trusted New Jersey personal injury lawyers at Shebell & Shebell can help you get compensation and hold responsible parties accountable. We represent clients throughout New Jersey, including Monmouth County, Middlesex County, and Ocean County, including Howell, Freehold, Middletown, Shrewsbury, Wall, Union Beach and Neptune. For a free consultation, call us at 732-532-2011 or contact us online today.