A personal injury settlement can provide necessary relief following an accident, however, such a an award may affect your taxes. Whether taxes will be affected by a personal injury settlement depends on the size of the award and the types of damages compensated for. There are federal guidelines that govern which parts of a settlement can be taxed, and how much much a person will owe. Since this can be a complex matter, a tax and Sacramento estate lawyer can help determine how a person’s personal injury settlement and finances will be affected under certain tax laws.
Compensatory Damages
Compensatory damages in a personal injury settlement are in place to reimburse for any losses sustained from the injury. These damages often include medical costs, lost wages and other financial expenses caused by the accident. Whether a compensatory damage is taxable or not depends largely on the type of damage and how it is treated. Generally, any reimbursements exceeding the damage value or considered income are likely to be taxed.
- If an itemized deduction for medical and injury related damages was taken, then they may be taxable. If deductions were not taken, then taxes are not required for these damages.
- If any compensatory damages received in the award are for lost wages from the injury, then that portion of the award is likely taxable. Damages for lost wages are intended to compensate a victim for any loss of income as a result of the injury. Compensation for wage loss damages are then considered income, so will be taxed accordingly.
- Compensation for property damages or loss-in-value of property that is equal to or less than the damages will not be taxable. If the compensation exceeds the damages or the value of the property, then the difference is then considered income and will, therefore, be taxable.
Punitive Damages
If an accident was caused due to extreme negligence or with willful intent, then it is likely that punitive damages are compensated for in the personal injury settlement. Punitive damages exceed the general compensation and are awarded to the victim as punishment to the defendant. Because these damages are not specific to the injury, suffering or loss of the victim, they are often considered as income, and thus, taxable by the IRS. Depending on the amount of the award, taxes to be owed for punitive damage will vary.
Federal tax liability guidelines can often be misinterpreted, making it difficult to determine how individual personal injury settlements can be taxed. Speaking with a tax and estate lawyer in your area can offer clarification on the matter. In addition, he or she can ensure that you receive the proper amount you are owed, while avoiding potential fines and penalties.
Thanks to our friends and contributors from Yee Law Group for their insight into personal injury settlements and tax implications.