The day you accept the settlement from the insurance company or defense attorney is a huge relief; your case is resolved! But you may be wondering, is a personal injury settlement taxable? In some cases, the Internal Revenue Service (IRS) is entitled to part of your settlement. In this article, we’ll look at some of the scenarios where a personal injury settlement is taxable.

Compensation for Physical Injury: Not Taxable

As a general rule of thumb, the proceeds received from personal injury claims are generally not taxable. Neither the state nor the IRS can tax you on proceeds from most personal injury claims. The IRS does not consider this type of income to be a wage or salary, but there are exceptions to the rule.

Important Exceptions 

If your physical injury or physical sickness is related to a breach of contract, you will get taxed on your settlement. If a breach of contract causes the damages or the breach of contract is the basis of your lawsuit, the proceeds are taxable.

Punitive damage claims are always taxable even when received in a settlement for physical injury or physical sickness. This is because punitive damages are not to compensate for a financial or emotional loss. During this trial, your lawyer will ask the judge or jury to separate the verdict into compensatory and punitive damages. Separating the two will allow the compensatory damages portion not to get taxed by the IRS.

Another exception is for interest on the judgment. In many states, court rules add interest to the verdict for the length of time the case is pending. Your taxable interest starts the day you filed your suit and ends the day you receive payment.

Claims for Emotional Injury: Taxable

As we mentioned earlier, your settlement is non-taxable as long as it’s from a physical injury. If you have a claim for emotional distress or mental anguish, with no physical damage, the settlement is taxable. If the proceeds received from emotional distress originate from physical injury or physical sickness, they are treated the same as proceeds from physical injury or physical sickness. This means that your settlement is not taxable if you can prove even the slightest amount of physical injury.

How to Maximize Non-Taxable Proceeds

In some cases, you may have two claims against the defendant – one that is related to personal injury and one that is not. You will want to explicitly state in the settlement agreement which amount relates to the personal injury claim and which amount relates to the non-personal injury claim, especially if the personal injury claim is the larger claim. The IRS can challenge the non-taxability of a settlement, but specifically allocating your settlement between personal injury and non-personal injury will give you the best chance of getting most of your settlement excluded from taxation.

Bonnici Law Group Can Help 

We hope this article helps you understand when a personal injury settlement is taxable. If you want to learn more, you can read the IRS settlements taxability publication here. Our team understands the complex legal issues of injury settlements, and we will work to maximize your amount of non-taxable proceeds. For a free consultation, call us at (619) 259-5199 or schedule it here on our website.