If you recently won a substantial settlement or jury verdict in a personal injury lawsuit, you may wonder how much of your windfall the government can take in taxes. Depending on the type of compensation you received, the government may not have the ability to tax it, and your attorney can help you determine which types of compensation could qualify for taxation.
Taxation for Different Types of Compensation
Both federal and state laws prevent taxation of any proceeds from a personal injury claim involving a physical injury or illness. For accidents, a plaintiff who succeeds with a personal injury claim for a back injury after a car accident could receive compensation for his or her medical expenses, ongoing treatment and rehabilitation costs, lost income from time missed from work, and the pain and suffering caused by his or her injuries. Since these damages resulted from a physical injury, the government would not tax any of it.
The law is very clear, however, concerning the distinction of “physical” injury. The plaintiff in a personal injury claim must have suffered some kind of measurable, observable injury or illness resulting from the defendant’s negligence to ensure his or her lawsuit proceeds are safe from taxation. For example, if you filed a personal injury claim purely for economic losses or for emotional suffering, the proceeds would not be immune to taxation since they did not result from a physical injury or illness.
Multiple Claims in One Lawsuit
It is also possible for a plaintiff to claim compensation for different kinds of damages in a single lawsuit. For example, a person hires a contractor to renovate his or her house, and the contract stipulates the contractor will ensure worksite safety. The contractor fails to do so and not only causes an accident resulting in severe property damage but also injures the client. In this situation, the client would have grounds for both a breach of contract lawsuit and a personal injury lawsuit due to the contractor’s negligence.
In this example, the damages collected from the breach of contract claim would qualify for taxation since they do not pertain to a physical injury. The damages related to the personal injury claim, such as the plaintiff’s medical expenses, lost income from recovery time, and pain and suffering, would not qualify for taxation.
If you have a claim against someone else that involves different claims, you must ensure your attorney can explain how your compensation applies to your damages. Following the example of a breach of contract in conjunction with a personal injury, it is in the plaintiff’s best interests tax-wise to claim the majority of compensation through the personal injury damages, not the breach of contract.
Punitive damages in a personal injury lawsuit are almost always taxable. If you receive any type of punitive damages from your lawsuit it is best to ask the judge for a clear explanation of your damages so you can prove your tax obligation to the IRS if necessary. Punitive damages are a means of further punishing a defendant in a personal injury claim for egregiously negligent or criminal behavior. The defendant may face criminal charges from the state as well, but the state’s job is to ensure justice, not to provide recovery to the victim. Punitive damages are therefore a punitive form of compensation and do not qualify for tax-exemption like other damages.
If you have any concerns about your tax obligations from a personal injury settlement or jury award, you should consult your personal injury lawyer and see how he or she plans to delineate the different types of compensation in your claim for tax purposes. If you fail to pay taxes as required on your lawsuit, you may face a heavy tax penalty, fines, or possibly even fraud charges.