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Tax Liability on Personal
Injury Settlements

If you’ve been offered a settlement for a personal injury claim, you may be wondering, “Do I have to pay taxes on an accident settlement?” If you do, then you have to consider the tax implications and decide if the settlement will be enough after taxes come out. At The Lanier Law Firm, we’ve put together a helpful guide on taxes after receiving a personal injury settlement.

Will you need to pay taxes on an accident settlement?

Sometimes, personal injury settlements are taxable. Other times, they’re not. Whether you need to pay taxes will depend on the kind of settlement you’re receiving, how quickly you receive the money, and how much of that money you can offset with expenses from a physical or emotional injury.

It’s no secret that the U.S. tax code is complex, and it can be confusing as well. With personal injury settlements, the settlement could be viewed as taxable income.

Fortunately, different aspects of a settlement are subject to varied rules and requirements, and you may have the option of using exemptions to reduce your tax burden.

Here’s more on what you need to know about paying taxes on an accident settlement.

medical bill compensation

Medical Bill Compensation

Compensation paid to you for your medical bills may not be taxable. For example, if you’re walking down the stairs at your local store and you slip on a wet spot, you could end up in the hospital with a head injury and have thousands of dollars in medical bills. If the business agrees to pay for your medical expenses, the money you received should be exempt from taxation.

When you have an illness or injury, you do not pay taxes if you did not take an itemized deduction for the medical expenses you accrued in previous years. You shouldn’t include the settlement’s proceeds when you report your income for the year.

There are exceptions to this rule, which is why it’s a good idea to talk to your accountant or tax professional. They can help you determine if you can deduct past medical expenses to help reduce what you owe to the IRS.

lost wages and repayments for time off work

Lost Wages and Repayments for Time Off Work

On Form 1040, you do need to report any income you receive during a settlement in an employment-related lawsuit. If you receive a settlement for lost profits from your trade or business, a portion may be subject to self-employment taxes.

If you have received compensation for lost business income, then the proceeds should be included when you report your business income on your tax return. If you received compensation for an employment-related lawsuit, then it should be reported on line one of your Form 1040.

property damage and compensation for property loss

Property Damage and Compensation for Property Loss

The damage to your property may have been severe. If the property settlement is less than the adjusted basis of the property’s value, then you usually do not need to report the compensation on your tax return. You do, however, have to reduce the basis of the property by the amount of the settlement.

More simply put, if you have $1,000 in damages and receive $1,000 in compensation, the income is a wash. You have no losses or earnings.

punitive damages

Punitive Damages

According to the Internal Revenue Service (IRS), the punitive damages received for injuries are taxed. They are reported as “Other Income” on your tax return. You have to report the damages even if the payment was for physical illness or injuries.

interest income earned from a settlement

Interest Income Earned from a Settlement

If you receive interest income, that does have to be reported and may be taxed as income.

Is a judgment treated the same as a settlement?

In the eyes of the Internal Revenue Service, a judgment is the same as a settlement. Whether the judge and jury determined that you should be awarded a certain amount of compensation or you agreed to enter into a settlement, the tax laws treat your case the same.

Can you owe taxes to the state as well as the government?

Yes. While most people only think about the federal tax liability they could face, they should remember that they could also be charged at the state level. In some cases, you could even be charged at the local level. For that reason, it’s a good idea to talk to your accountant about ways to minimize taxation. Otherwise, you could face taxation from two or three government entities during the same year, which would greatly reduce the value of your personal injury claim settlement.

Will you need to pay taxes to the government in advance?

You may need to pay estimated payments to the federal government. Estimated payments are paid four times a year, once per quarter. Generally speaking, you pay estimated taxes to the state only when you have had no taxes withheld from certain kinds of taxable income.

As for federal payments, estimated payments are usually required when the tax liability is expected to be $1,000 or more once withholding and credits are subtracted.

You Could Reduce Your Liability with the Right Techniques

two people looking at a document There are ways that you may minimize the taxes you’ll pay, such as:

  • Creating an itemized settlement to go over the losses a recovery is repaying
  • Structuring your settlement in a way that allows it to be paid to you over
    time, so you don’t have a hefty tax bill during a single tax season
  • Using exemptions and deductions to reduce the tax burden

These and other options may be available to help reduce what you owe and
protect your income.

There are ways that you may minimize the taxes you’ll pay, such as:

  • Creating an itemized settlement to go over the losses a recovery is repaying
  • Structuring your settlement in a way that allows it to be paid to you over
    time, so you don’t have a hefty tax bill during a single tax season
  • Using exemptions and deductions to reduce the tax burden

These and other options may be available to help reduce what you owe and
protect your income.

Talk to An Accountant or Tax Professional
Regarding a Personal Injury Settlement

After you receive a settlement, it’s normal to want to move on with your life. You want to use the money to pay off expenses and get your life back to normal.

The idea of taxation doesn’t always cross someone’s mind when they’re dealing with a personal injury, but it is something that you have to consider when you’re negotiating your settlement. Taxes may change the amount of money you walk away with, so you have to be aware of how they’ll impact your injury claim and any settlement or judgment you receive.

An accountant or tax professional can help you save money and avoid taxes coming out of your injury settlement or judgment. With the right approach, it’s possible to minimize the taxes you pay, so you can keep more money in your pocket and avoid losing out to the IRS.

At The Lanier Law Firm, we can help you understand your rights and make the most of your personal injury claim. Reach out at (212) 421-2800 to learn more today.

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