How Personal Injury Settlements can Effect your Taxes and Annual Filing Deadlines

If you have won a personal injury case and are receiving a monetary settlement there are important tax considerations that you will need to be aware of. Many settlements come in a lump-sum payment, especially if an insurance company is trying to avoid a trial. You may also receive payments spread out over time depending on the amount of the settlement and your specific circumstances. No matter how personal injury settlements are paid they can affect your taxes and annual filing deadlines.

You should know that when you agree to a settlement, the settlement amount should always be broken down into the different types of damages you are being paid for. When you receive your settlement payments, each payment should be issued into the proper category and the reason it is being paid to that category should be noted on the checks or on any 1099 IRS forms you receive. In other words, you may be receiving money for punitive damages, damages involving  lost wages, both present and future medical damages, and your attorney’s fees. You will need to understand your responsibility to pay taxes or not pay taxes on the funds you receive. You also need to know that if your receive a large sum of money you may be required to make quarterly tax payments and not just wait to the end of the year to pay taxes owed on a large settlement.

Damages Specific to Compensation for Loss of Health

A person who gets seriously injured will have a lot of medical bills. It shouldn’t be that person’s responsibility to pay for those bills if the injury was caused by another. That is why a settlement for an injury like a medical malpractice suit will usually have an amount that specifically covers the medical expenses. The compensation for injuries may also include estimated future medical cost or losses based on your physical injury and the care needed. When it comes to compensation to cover medical bills and injuries, you usually will not have to pay taxes on this type of settlement.

Damages for Lost Wages 

Compensation for lost wages is normally taxable and considered normal income.

Emotional Distress Damages

If you add emotional distress to your claims, you should know that the funds you receive as a result of emotional pain or suffering issues will be taxed. The one exception to this rule is that if the emotional distress was brought on by the physical injury. If the physical injury is the cause then you may escape paying taxes on this amount, talk to your accountant.

Punitive Damages

Punitive damages are also commonly included in legal settlements. Punitive damages are a form of financial punishment for the responsible party of the injury and these damages can be substantial. If you decide to sue for punitive damages and win, you will be obligated to also include these damages on your tax return along with any interest gained on the punitive damage award.

Legal Fees

Sad to say, but legal fees are normally not tax-deductible. This can be a killer on your settlement funds as lawyer fees can add up to close to 50% once you add in the contingency fees and all the costs the lawyer incurred. Unless your case is a business lawsuit, or only for physical injuries or maybe an employment dispute, you will have to pay taxes on the total settlement reward, without deducting the legal fees paid to your lawyer.

Have Your Settlements Separated in the Settlement Agreement

It’s important that lawyers distinguish how different funds are allocated and for what purpose. You could get in trouble for not reporting some of your income because you aren’t certain which part of your settlement check is for what kind of damage. It does not matter if your settlement is from a class action lawsuit or from civil litigation, if you are getting a large sum of money you need to understand the tax laws. Work with your lawyer to make sure all settlement funds are identified in all legal documents and show which funds are paying for what specific damages. This will help you avoid making mistakes on your tax returns. The last thing you will want is to have to pay a late fee or a penalty on top of all the other taxes you may owe.

If you are curious as to how much you will be taxed on a current settlement offer, you should contact an accountant. It is important that you, your accountant and your lawyer do some tax planning before any settlement is reached and make sure the settlement agreement clearly shows what category of damages any funds are going to. Together, the three of you should be able to make the correct and best decision in how the personal injury settlements will affect your taxes and annual filing deadlines.