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Is a Personal Injury Settlement Considered Income?

If you've been awarded a personal injury settlement in a recent case, or are expecting such a settlement sum in the near future, you may already be thinking about important areas like taxes and tax returns with regard to this sum of money. In particular, a common question is regularly asked in these scenarios: Is a personal injury settlement considered income that's then taxable on your yearly tax return?

At the offices of William Rawlings & Associates, we happily assist clients around Salt Lake City, Provo, Draper and surrounding areas of Utah with all their personal injury attorney needs, from auto accident lawyer services and motorcycle accident attorneys to areas like dog bite claims, wrongful death and more. Here are some of the elements of a typical personal injury settlement, plus some of the ins and outs of whether they will be considered taxable income. 

Personal Injury Settlement Considered Income

Medical Bills

One of the more nuanced areas when it comes to personal injury settlements and taxation relates to medical bills. A couple relatively consistent tenets of IRS qualification to keep an eye on here:

  • Physical injuries or illnesses: In most cases where a personal injury settlement arises directly from a physical injury or illness sustained by the victim, it won't be taxable. An exception here will sometimes be if the settlement is intended to replace your income for some period of time, in which case it may be considered taxable.
  • Previous claim: However, if you have already claimed medical deductions on your taxes due to the injury or sickness in question, the settlement will become taxable. This is because you have already seen the financial benefits of the settlement in a previous tax return. 

Emotional Distress

Also known as mental anguish, this is another area that's somewhat nuanced. Generally, whether emotional distress portions of a personal injury settlement will be considered income will depend largely on whether these sums relate to the subject of the settlement itself. 

That is, if you undergo emotional distress as the direct result of a physical injury like those mentioned above, it's unlikely the IRS will consider this taxable income. But if a settlement is based purely on emotional distress with no physical element involved, it may be considered income and taxed as such.

Lost Wages

In most cases, any portion of your personal injury settlement that's specifically designated to replace lost wages from missed work as a result of the injury will be considered taxable income. In these cases, your employer may also be required to report this income and issue you a W-2 form at the end of the year.

However, if you are receiving disability payments for lost wages through an insurance policy, these generally will not be considered taxable income. This is because they are meant to compensate for lost wages and do not represent income. 

Punitive Damages

For those unfamiliar with them, punitive damages refer to those set aside in cases where the defendant is found to have acted with gross negligence or malicious intent. These are meant as a punishment for such actions, rather than to compensate victims for specific losses.

The IRS considers punitive damages to be taxable income in most cases. This applies even if they're part of a personal injury settlement that also includes non-punitive sums – only the punitive portion will be taxed, while the others may not be if they meet the criteria outlined above.

In fact, punitive damage taxation tends to override some of the other basics we've gone over here. For instance, even if the punitive damages are directly related to physical injury or illness, they will not receive the same tax exemption that other portions of a settlement might. 

Settlement Interest

In some cases, particularly if a large punitive damage payment was part of your settlement, you may consider investing some or all of the sum. In these cases, it's important to remember that any interest you receive from this investment will be considered taxable income – even if other portions of your settlement may not be.

In addition to these factors, there are some special considerations for certain types of personal injury settlements. For example, if your settlement includes reimbursement for attorney fees or legal costs, these may be considered tax-deductible. Additionally, if your settlement is paid out over multiple years, this could potentially impact the way it's taxed each year. 

Ultimately, the specifics of your personal injury settlement will dictate its taxation – for these and any other relevant areas or questions, our experienced attorneys are here to provide guidance and expertise. Contact our team at the offices of William Rawlings & Associates to learn more about any of our personal injury attorney services around SLC, Provo, Draper or nearby areas of Utah.

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