In general, personal injury settlements are not taxable. Taxes do not apply to compensation you received because of physical pain, emotional distress, or psychological harm done to you by another person. The Internal Revenue Service (IRS) grants tax exemptions for “compensatory” damages to recompense victims for their losses and suffering.
It can be challenging to determine which settlements are subject to taxation and which are not.
According to the IRS, the critical question in determining if the settlement is taxable is: “What was the settlement (and its corresponding payments) intended to replace?” If you’re unsure, a skilled Newaygo Personal Injury Attorney can help you understand the complexities of taxation relating to damage awards and settlements.
Types of Non-Taxable Settlements
Generally, settlements for physical harm or personal injury are non-taxable. But there are cases that include other types of non-taxable settlements. To know more, here are a few of them:
1. Vehicle Accident Injury Claims
Michigan’s no-fault insurance has Personal Injury Protection (PIP) that covers your medical bills, suffering, sickness, and even wage loss due to a car accident. PIP is considered non-taxable. Attendant care, however, is regarded as an income subject to taxation.
2. Dog Bite Claims
Dog bites are classified as physical injury claims, are not taxable, and are often not required to be reported to the IRS.
3. Medical Malpractice Claims
Medical malpractice claims are also considered personal physical injury as it causes harm, pain, emotional suffering, and distress to the victim. Thus, any financial compensation under this claim is non-taxable.
4. Wrongful Death Claims
Any compensation or settlement for wrongful death, including unintentional deaths, fatal accidents, or intentional acts, is exempt from taxes because it is considered a form of personal physical injury.
5. Premises Liability Cases
A premises liability claim is filed when a property owner’s negligence leads to another person’s physical injury or loss. Because it’s still considered a form of personal physical damage, it’s not taxable.
As complicated as taxation already is, there are more factors and circumstances to consider when it comes to settlements and damage awards. Remember that there will always be exceptions to the rules. So, here are some examples of settlements related to personal injury that are considered taxable.
1. Emotional distress not related to physical injury
The IRS clearly states that any compensation for emotional pain or mental suffering must result from a personal physical injury. Otherwise, any proceeds must be treated as income and will be taxed. The amount, though, may be reduced under certain conditions.
2. Lost wages or profit settlement as net earnings
If a portion of the compensation you received for lost wages or profit as a result of the personal injury was used to support the operations of your business or company, it means your company benefited from it. As a result, it is considered net earnings, is subject to self-employment tax, and must be reported as part of “business income.”
3. Punitive damages
Punitive damages, also called “exemplary damages,” is compensation paid to the victim in addition to “compensatory damages.” If the compensatory is intended to compensate the victim for their pain, the exemplary is intended to punish the defendant for their misconduct.
4. Back pay for tax break
Suppose a portion of the compensation you received went to cover medical expenses that you were able to deduct in the previous year (or years) that resulted in a tax benefit. In that case, you must declare it as part of your income. It then becomes taxable.
5. Interest Earned
If the defendant requests a certain amount of time to settle their finances because the settlement is too large for them to pay, the money will eventually accrue interest. The compensation for personal physical injury is still non-taxable, but the IRS will tax the interest earned.
How Long Does It Take to Get a Settlement?
As each claim is unique, there’s no clear-cut timeline for a settlement to be resolved. However, many legal experts estimate that a typical settlement takes 4 to 6 weeks. Sometimes longer, depending on the parties and other factors. For this reason it is crucial to have an experienced Newaygo Personal Injury Attorney to expedite the process.
Get the Settlement You Deserve
If you’re still scratching your head as to which personal injury settlements are or are not taxable, have no fear – our experienced team of legal experts have the answers! Nolan & Shafer understands that taxation can be draining and challenging, especially in regards to damage awards and compensation. Consult us and we’ll make it easy for you. Call us at (231) 722-2444 to schedule an appointment. You can also reach us here.