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Personal Injury 101: Is a Personal Injury Settlement Taxable?

A personal injury case is settled after you accept the settlement amount offered by the defense attorney. Most personal injury cases involve a large sum of money. The compensation amount sometimes goes into millions.

So, what happens after you receive the personal injury compensation amount? Is the compensation amount taxable? During tax season, this is a relevant question that crops up in the minds of people as they prepare to file personal taxes. If this is the case with you as well, you will find guidance in this article.

About Taxation on Personal Injury Settlement Claim

Generally, the personal injury settlement amount is not taxed. The principle applies whether the compensatory amount is paid in lump-sum or over a certain period.

According to the Internal Revenue Code subdivision (a)(2); California Revenue & Tax Code §17131, if the compensation was awarded due to a physical injury or sickness, the amount paid to the victim is treated as “payments on account of the injury or sickness”. This is the case even if the recipient received compensatory damages for emotional distress.
However, there are certain exceptions regarding tax exemption of personal injury compensation amount. You can owe taxes to the IRS related to the personal injury compensation amount in any of the following cases.

Interest on Compensation Amount

Any interest earned from a personal injury compensation amount is taxed. The interest is not in the tax-exempt list and is included as ‘interest income’ on the 1040 tax form.

Additional Benefits

In case you have obtained a tax benefit in the past related to out-of-pocket medical expense for personal injury, you need to repay the amount to the IRS.

Let’s suppose that you have deducted the cost of medical care associated with an accident when filing previous year income tax. This is allowed and legal. However, if you later receive compensation for personal injuries, you need to pay back what you had deducted in the past when filing the current tax return. The tax break should be included in the current tax statement as ‘other income’.

Punitive Damages

The tax exemption is also not applicable in case of punitive damages. Punitive damage is not awarded for any emotional or financial loss suffered by the plaintiff. Instead, it’s awarded to punish the defendant for negligent behavior. Not including such amount in the tax form is a costly mistake that can result in a hefty penalty.

Do you reside in San Bernardino, Hemet, Inland Empire, or surrounding areas in Southern California? If so, you can contact Albert E. Hirst, an experienced personal injury lawyer for experienced help and guidance regarding your personal injury case. For more information, you can get in touch with us by dialing (909) 885-7190.

*Albert E. Hirst is not a CPA or tax professional. This article serves to provide general information, but should not serve as a definitive answer to your question. Laws, state tax code and regulations vary by state. Consult with a CPA or tax professional before making any decisions regarding your finances.