When Personal Injury Settlements are NOT Subject to Taxes
As a rule of thumb, any monetary damages recovered via a personal injury settlement are not subject to state or federal taxation. This general exclusion from income taxation applies to settlements in which you recover damages for the expenses incurred as a result of your physical illness or bodily injury (e.g., after a car accident) and pain and suffering related to the physical injury. However, federal and state laws are subject to changes, which is why you should consult an accountant to determine whether or not your damages recovered via a settlement are excluded from federal or state taxation.
When Personal Injury Settlements are Taxable
Damages for pain and suffering for emotional distress are taxable as emotional distress is not a “physical” injury. Furthermore, damages recovered for lost wages are taxable. Also, punitive damages are subject to taxes. A person is eligible to receive punitive damages when the other person’s conduct was especially outrageous or egregious. Thus, punitive damages are a form of punishment and are paid to deter the defendant and potentially other individuals from engaging in similar conduct.
There are other instances where a personal injury settlement could be subject to taxes. For example, if you deducted the cost of medical expenses from your taxes the previous year, you must include that deducted portion of the proceeds as taxable income. You must also pay taxes on any post-judgment interest that accrues on a jury award. This is quite common when a plaintiff is awarded a sum of money, and then the defendant appeals the judgment.
After any settlement or award, it is wise to consult with an accountant to determine which portions, if any, of your recovery are taxable.