What To Know About The Taxability Of Your Personal Injury Settlement
If you've been suffered physical, financial, or emotional injuries after an accident, you may be entitled to compensation from the person or business responsible for these injuries. But even after you've received a settlement offer, the process may be far from over. Failing to take the taxability of your settlement into account when deciding whether to accept or reject a settlement could cost you dearly in the long run. If you assume your settlement is tax-free, only to be hit with a tax bill of 25 to 35 percent of the total, you may find yourself wishing you'd proceeded with your lawsuit instead. Read on to learn more about how personal injury settlements are taxed and what you'll want to confirm before signing a settlement agreement to dismiss your case.
What Settlement Funds are Tax-Free?
In general, settlement funds that are designed to compensate you for losses you've suffered, termed "compensatory damages," won't be taxable. The idea behind this is that you've already incurred these costs, through no fault of your own, so assessing federal and state income taxes on these costs would be an unfair burden.
Compensatory damages commonly include claims for things like medical bills, lost wages, out-of-pocket expenses related to the accident (like medical devices, rental car expenses, or a spouse's unpaid time off work) and personal property damages. The settlement agreement should specifically state what percentage of settlement funds are designated as compensatory damages; otherwise, it can be tough to untangle how much, if any, of the funds received are taxable.
What Settlement Funds are Taxable?
Punitive damages, or those designed to punish a defendant or deter him or her from future negligence, are always taxable. But in the settlement context, it can be unusual for a defendant to admit fault and offer anything called "punitive damages;" instead, these damages may just be general damages above and beyond the actual out-of-pocket costs. Generally speaking, any settlement funds that exceed the amount of damages you've incurred will be considered taxable.
What if the Case Proceeds to Judgment?
If you and the other party aren't able to reach a settlement agreement, a judge or jury may decide your case at trial. If you're awarded damages, the same tax considerations will apply. The court's order will usually specifically set out the judgment categories, including compensatory damages, punitive damages, and sometimes even separate attorney's fees. It's important to keep a copy of this final court judgment for at least a decade, as it can be a huge help if you're selected for a random audit.
Contact an attorney, like Nicholas B. Hall - Personal Injury Lawyer, for more help.