Personal injury settlements or awards often take months or years and frequently follow a lengthy period of emotional, financial, and physical suffering. When you receive a settlement or a verdict award in your favor in a personal injury lawsuit, you likely want to collect all of the compensation for your losses minus your attorney's fees. You might also wonder whether you will have to pay any taxes on your settlement or award to the state and federal governments. While a large portion of your award or settlement will likely not be taxed, portions of it might be. There are some distinctions between the various types of damages that might be awarded in your case. Here is some information about taxation and personal injury settlements and awards that you should know from the Los Angeles injury attorneys at the Steven M. Sweat, Personal Injury Lawyers, APC.
Understanding State and Federal Taxation
Californians who earn more than a minimum threshold amount must pay income taxes to the California Franchise Tax Board and the Internal Revenue Service. While some states such as Oregon do not have state income taxes and instead have additional sales taxes, California is one of the states that does have a separate income tax requirement in addition to the federal income tax requirement. However, not all forms of income are considered to be taxable. The state and federal tax codes are separate. However, the portions of a personal injury award or settlement that are considered taxable income by the IRS will also likely be considered taxable income by the California Franchise Tax Board. Below are some frequently asked questions about the tax treatment of different types of damages.
1. Do You Have to Pay Taxes on Damages for Past and Future Medical Expenses?
Under 26 U.S. Code § 104(a)(2), compensation that you recover for your medical expenses for your physical injuries is excluded from your gross income and is generally not taxable by the IRS or the State of California. Damages for your past and future medical expenses are not considered taxable income because they are considered to be reimbursem*nts for the money you have been forced to spend to receive treatment for your injuries and for the amounts you will likely have to spend in the future.
However, if you claimed itemized deductions for some of your medical expenses on your income tax forms while your lawsuit was pending, you will have to include those amounts and report them to the IRS under 26 U.S. Code § 104(a). This subsection specifically states that any medical expenses that you claimed as itemized deductions during the year when you incurred them cannot be later excluded from your gross income when you receive your settlement or verdict award. However, you will not have to report any of your other medical expenses to the IRS or the Franchise Tax Board beyond the medical expenses you claimed as itemized deductions. If you only took the standardized deduction and did not itemize your medical expenses, none of the portions of the settlement or award you received for medical expenses will be taxable.
2. Do You Have to Pay Taxes on Damages for Past and Future Lost Wages?
While you can exclude most or all of the compensation you receive for your medical expenses, the same is not true for the compensation you receive for lost wages, including past lost wages while you were unable to work and for future lost wages if you were left with a permanent disability that prevents you from returning to work. Since these types of damages are meant to replace the income you would otherwise have earned from work and would have paid taxes on, they are considered to be taxable by the IRS and the State of California and will need to be reported. Typically, this will be the largest portion of your settlement that you might need to pay taxes on.
3. Do You Have to Pay Taxes on Damages for Property Losses?
Depending on your type of personal injury matter, you might also receive compensation for property damage. These types of damages are typically awarded in auto accident claims. Since these types of damages are meant to reimburse you for the money you had to spend to repair your vehicle or replace it, they are generally not taxable and will not need to be reported. However, if you receive damages for the reduction in the value of your property, the IRS states that you must report the difference if you receive more than your property is worth. For example, If your vehicle was worth $20,000 but you received $25,000, you will need to report the $5,000 difference on your state and federal income tax returns.
4. Do You Have to Pay Taxes on Damages for Pain and Suffering?
Most personal injury settlements and awards also include compensation for pain and suffering damages. These are non-economic damages that can be recovered in addition to your monetary or economic losses. The compensation you receive for your physical pain and suffering arising from your physical injuries is not considered to be taxable and does not need to be reported to the IRS or the State of California.
Damages that you received for the emotional pain and suffering that you experienced that arose from your physical injuries are also not taxable. However, if you only suffered emotional pain and suffering damages and did not suffer any physical injuries, they will be taxable and must be reported to the IRS and the state. Most personal injury lawsuits involve physical injuries, so this means that most plaintiffs will not have to pay taxes on the emotional pain and suffering damages they might receive.
5. Do You Have to Pay Taxes on Punitive Damages or Interest?
In some personal injury lawsuits, punitive damages might be awarded. These types of damages are paid on top of any compensatory damages you might be awarded for your economic and non-economic losses. They are normally only awarded in cases in which the defendant's actions were particularly outrageous and are meant to punish the defendant. A defendant might also be ordered to pay interest. If you are awarded punitive damages or interest, you will have to report them to the state and the IRS and pay taxes on them. Prejudgment interest cannot be awarded on non-economic losses. However, it might be awarded for damages for economic losses such as lost wages and funeral and burial expenses in a wrongful death action under Canavin v. Pac. Southwest Airlines, 148 Cal.App.3d 512 (1983).
Punitive damages are rare in personal injury lawsuits, so you might not have to worry about whether you will need to pay taxes on punitive damages. However, if the defendant's conduct in your case was particularly egregious, they might be awarded. If so, you will need to report them on your income tax returns and pay taxes.
6. How Do You Figure Out How Much of an Award Is Allocated for Each Category of Damages?
Since different portions of an award or settlement might receive different tax treatments, it is critical that the breakdown of the various amounts is thorough and complete. Your attorney will ask for a documented, full breakdown of your damages. If your lawsuit involved additional claims beyond your personal injury claim, your attorney will also want to know which damages are allocated to which claim.
Talk to an Experienced Personal Injury Attorney
The state and the IRS will only be able to take a small portion of your total personal injury award or settlement since a large portion of it will not be considered to be taxable income. Once you pay your attorney's fees and legal costs out of your award or settlement, you will be able to keep the remainder minus any taxes that might be owed for damages for your lost wages, punitive damages, or interest. However, if you succeed in your claim, the amount you might receive should be enough to help you to recover. To learn more about your case and your rights, contact the law firm of Steven M. Sweat, Personal Injury Lawyers, APC at 866-966-5240.
