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What Amount of an Injury Settlement is Taxable?


If you have filed a personal injury claim and you’re pretty hopeful of its chances, you are probably looking forward to getting a fair settlement that helps you cover your losses and try to get back to where you were before your accident, injury, or illness that was caused by the defendant. What you are probably not looking forward to is the Internal Revenue Service (IRS) trying to get a share of any injury settlement you get. Like most personal injury claimants, you might be surprised to find that the IRS can tax an injury settlement if the settlement or a portion of it is considered taxable gross income.

When Isn’t Gross Taxable Income for an Injury Settlement?

To begin, you should know that not every injury settlement is taxable. Many aren’t due to the rules that the IRS set itself.

IRS 26 U.S. Code Section 104 states that compensation earned through an injury claim is not gross taxable income if it meets these criteria:

  • Money received through a workers’ compensation claim.
  • Non-punitive damages received in a settlement or agreement.
  • Non-punitive damages awarded in a lawsuit by a judge or jury.
  • Compensation from an accident insurance or health insurance company.

It’s important to make the distinction between compensatory damages and punitive damages. Compensatory damages are meant to compensate the plaintiff for losses they have already suffered and are also called non-punitive damages (see above), so they generally aren’t taxable, but exceptions do exist. Compensatory damages can be sorted into economic damage and non-economic damage, too. Punitive damages are meant to punish the defendant for doing egregious wrong, and they generally are taxable.

Are Settlements for Out-of-Pocket Expenses Taxable?

No, the IRS typically does not tax any settlement portion that is meant to cover the out-of-pocket expenses you incurred due to your accident and injuries. Such a settlement would essentially reimburse you for what you lost, which would not “put you ahead” as income does; instead, it would put you back to where you should have been had there never been an accident or injury. Therefore, the IRS does not consider settlements for out-of-pocket expenses as a form of taxable gross income.

What Part of an Injury Settlement Can Be Taxed?

Depending on where you live, the tax law will look a little different from the next state over, so part of your injury settlement could become taxable. As discussed, non-punitive damages are usually not taxable, but not always.

In some cases, the portions of an injury settlement that can be taxed could include:

  • Compensation for medical expenses if a deduction was claimed in a previous tax year.
  • Compensation for lost wages with consideration to applicable employment taxes.
  • Compensation for lost profits, either taxable as business income or self-employment taxes.
  • Compensation earned as an interest on a judgment.
  • Compensation for punitive damages meant to penalize the defendant.

Why Might Your Lost Wages Settlement Be Taxable?

The IRS might tax the portion of your injury settlement that repays you for lost wages and income. Why? The simple answer is that the IRS wants to tax every form of income earned by every American taxpayer, which includes compensation that replaces income that you would have earned had you not been in an accident.

Imagine that you usually earn $10,000 a month, so in one year, you earn $120,000, which is then taxed by the IRS. You miss a year of work due to a car accident. In the claim you file against the other driver with an attorney’s help, you demand $120,000 to make up for the year’s income you were unable to earn on your own. The case is a success, and you get a settlement, which includes $120,000 for your lost wages. The IRS will likely want to take that $120,000 portion of the settlement because it sees it as a form of income that you would have earned and been taxed on under normal circumstances.

Furthermore, if you are given a settlement for an employment law claim, such as a lawsuit after you were unlawfully terminated or discriminated against, the IRS might get involved again. If any of the settlement you are given is meant to cover wages that you lost or never earned due to an employment law violation, the IRS could consider it taxable gross income.

Will Your Injury Settlement Be Taxed?

For the most part, successful personal injury claimants or plaintiffs see minimal tax consequences on their settlements and awards. Punitive damages are rarely awarded, and economic damages for lost wages are usually not as significant as damages related to medical expenses, pain, and suffering. However, every case is unique and must be evaluated on its own merits. Where one plaintiff might see essentially no tax consequences after winning a settlement, another might be shocked by how much the IRS will consider taxable gross income.

If you want to know if your injury settlement will be taxed, you should start by working with a professional personal injury attorney in your area. A reputable lawyer can speak from their secondhand experiences as someone who has won many cases for injured clients about what tends to be seen as taxable gross income once a settlement or award is granted. For complex cases, your injury attorney might also be able to point you to a tax attorney they trust, so you can get more details about the answers you need to make sense of your potential settlement or award.

Do you need help with an injury claim in Las Vegas, Nevada? Make a call to Bertoldo Carter Smith & Cullen for legal counsel and representation that is backed by decades of legal experience and a trusted reputation among our peers—more than 85% of our cases come from word-of-mouth referrals and repeat clients! We would be happy to guide you through your entire case and answer all your questions, including those about how the IRS views settlements and awards as taxable gross income.

Call (702) 505-8115 to schedule a FREE case consultation with Bertoldo Carter Smith & Cullen.