Is Financial Compensation Taxable?

Considering that individuals who were injured in accidents often struggle with a number of unexpected financial obligations, it's no wonder that one of the most common questions our attorneys receive from prospective clients is about the taxability of personal injury settlements. At the Morris James Personal Injury Group, we understand. When you're paying for accident-related medical expenses, such as doctors bills and prescription medications, the last thing you want to worry about is paying taxes on a possible financial settlement. Fortunately, most of the compensation that personal injury victims receive is not taxable. However, there are some notable exceptions to that rule. Working with an experienced personal injury attorney can help you minimize the taxation of your settlement.

Tax Free Recovery

Money awarded to compensate a victim for bodily injuries, and related pain and suffering is usually tax free, so most of the time accident victims are not required to pay taxes on a personal injury settlement. This is because the financial settlement is intended to compensate the victim for losses caused by an injury and, as a result, is not considered “earned” income. Examples of non-taxable damages include money reserved for:

  • Medical bills
  • Pain and suffering
  • Emotional stress related to a physical injury
  • Attorney fees

Additionally, money paid to an accident victim to cover property damage to their vehicle usually isn't taxed, as it is also considered compensation for a loss.

Notable Exceptions

While, as a general rule, personal injury settlements are not taxed, there are a few notable exceptions worth mentioning. Examples of taxable settlement amounts include compensation related to:

  • A breach of contract. If a breach of contract caused your injury and breach of contract was the basis of your lawsuit, the related settlement may be taxed.
  • Lost wages or lost income. If a portion of your settlement was set aside for these purposes, that money is considered taxable “earned” income.
  • Interest. Some states add interest to the settlement for the time period that the case was pending. Any interest earned during that time is taxable.
  • Punitive damages. Also known as exemplary damages, punitive damages are those that are intended to punish the defendant for wanton or reckless actions, and discourage them from engaging in similar conduct in the future. Punitive damages are always taxable and are taxed in full.
  • Emotional Distress and mental anguish. If your mental and emotional problems arose from a physical injury sustained in an accident, the compensation received may be non-taxable. However, when you receive a settlement that compensates you for mental pain and emotional suffering not related to a physical injury, that compensation can be taxed.
  • Interest or profit earned from invested settlement proceeds. If you invest the proceeds of your settlement in an environment where it accrues interest or results in a profit, the interest and profit from the investment is taxable.

Were You Injured in an Accident?

If you were injured in an accident, you may be facing a long recovery period and a seemingly-insurmountable amount of medical debt. Filing a personal injury lawsuit can help you pursue the compensation you need to get your life back on track. However, with so much at stake, it's important not to go it alone. A knowledgeable and reputable attorney can walk you through each step of the personal injury process and fight to ensure you receive a fair settlement.

At the Morris James Personal Injury Group, our dedicated, driven attorneys have the negotiation and litigation experience you can count on. Whether we settle your case out of court or take it all the way to trial, our skilled legal team understands the concerns surrounding the taxability of personal injury settlements and will work with you to minimize that taxation. Complete our online contact form today to schedule a free initial consultation to discuss your case.