The IRS’s role in personal injury settlements can be quite puzzling. So, if you are expecting or have already received a settlement, the most pertinent question is, “Will the IRS take some of it?” The answer is straightforward: there will be some deductions, and there will be none. You may further segment the settlement into portions that are nontaxable and taxable.
It is important to grasp how tax regulations influence your settlement so you can prepare accordingly in order to not spring any shocking revelations on you. Here’s a more comprehensive elucidation.
What Is A Personal Injury Settlement?
This form of insurance pays the claimant who suffered some form of bodily damage because of another party’s negligent action. You might receive this from a car crash, a workplace mishap, a medical malpractice case, or a slip and fall incident.
Settlements usually include the following:
- Medical Cost
- Wages Not Paid
- Emotional Trauma
- Destruction to Property
Punitive damages (anadditional payment awarded over and above the compensatory damages to set an example for others)
But the big question is: Is this money subject to taxation?
When should personal injury settlements never be taxable?
Generally, a settlement that compensates for physical injuries or diseases is not subject to taxation. In other words, if you got money for the medical treatment, pain, and suffering, or work absences related to a physical injury, this portion is not taxable.
For instance:
If you got injured in a car crash and had to take $50,000 for medical treatment as well as pain and suffering, then in this scenario, you do not have to pay any taxes related to that amount.
It is also tax-exempt in this case if you settled a slip and fall case for $30,000 related to your hospital treatment, along with expenses and revenue lost due to your injury.
When Should the Settlements Be Taxed?
Punitive damages are damages given in order to punish the entity at fault for your injury, be it an individual or a company, hence the term ‘punitive’ (the IRS does place a tax on these damages). The IRS taxes these damages because they are not considered compensation for bodily harm.
If your settlement incorporates punitive damages in the amount of $100,000, you need to include that in your income for tax reporting purposes.
Emotional distress (if there is no physical injury).
Monies received as payments for emotional distress are taxable if there is no physical injury related to it.
Illustration: You filed a lawsuit against an employer for workplace bullying and received $20,000 for emotional distress. Since there was no actual bodily injury involved, this payment is taxable.
On the other hand, if emotional distress is a byproduct of a physical injury, it is tax-exempt.
Settlement Interest
There are times when a settlement is delayed in processing, and interest is accrued. The IRS will tax any part of your settlement that makes up for interest accrued.
Example: You obtained a settlement of $50,000, but $5,000 of it was known as interest. You will have to pay taxes on the $5,000 in interest.
Deducted Lost Wages
If you have previously deducted lost wages on a tax return in the form of a business loss or as a medical deduction, you will have to settle your taxes when you receive your settlement.
Ways to reduce taxes on your settlement
You can lower your settlement taxes in the following ways:
Consult a tax professional: A tax professional will help you devise the best strategy to get a higher amount than the minimum taxable amount on your settlement.
Identify the taxable and non-taxable portions: Make sure that during the negotiation phase of the settlement, the agreement specifies which part of it is for physical injury (non-taxable) and which part of it is for willful neglect infliction of mental pain and suffering (taxable).
Think about a structured settlement: rather than a one-time payment, you may elect to receive the money over several years to reduce the tax burden you have to deal with.
Is There a Requirement to Inform the IRS of the Settlement?
If your settlement is all physical injury compensation, you don’t have to report it on the return. However, any additions to your amount, such as punitive damages or interest, need to be declared.
How Can USA Settlement Loans Help?
The waiting period for the outcome of a personal injury case can be stressful, and it doesn’t help when you have bills to pay. USA Settlement Loans gives you a personal injury case loan in anticipation of the payout.
Benefits of USA Settlement Loan:
Fast cash when you need it.
There is no repayment if you don’t win your case.
The program assists in paying for medical expenses, rent, and other basic needs.
If you are waiting for your settlement and require some funds, USA Settlement Loan can offer the assistance you require.
Final Thoughts
Knowing whether or not a personal injury settlement is taxable can help in strategizing and avoiding roadblocks during tax time. Generally, settlements that are given for the sake of physical injuries tend to not be taxed; however, punitive damages, emotional distress (not associated with any injury), and interest are taxable.
Speak with a tax professional to ensure you receive your settlement correctly. Whenever you need funds while waiting for your case to settle, USA Settlement Loan will always assist you.
Are you looking for assistance during your wait? Don’t hesitate to reach for USA Settlement Loan today!