With Congress’s approval of a major tax reform bill in December 2017, many individuals’ federal tax returns will look much different beginning in 2018 (the new law does affect tax returns for 2017). However, one section of the tax code that is not changing is the section that deals with personal injury compensation.
If you receive a personal injury settlement or verdict, it is important to understand that you may owe federal income tax on a portion of your award. Here is an overview of the basic tax rules that apply:
IRS Tax Rules for Personal Injury Compensation
1. Compensation for Physical Injuries
As a general rule, any compensation you receive for medical treatment of physical injuries from a traumatic accident is not considered taxable income. This is true for both past and future medical expenses. However, if you deducted your medical expenses in a prior year (i.e. if you paid and deducted your medical bills in 2016 and received a settlement in 2017), then you may need to report the portion of your award that is attributable to the medical bills you previously deducted.
2. Compensation for Emotional Trauma
Emotional trauma resulting from a physical injury receives the same tax treatment as the underlying physical injury. If you have not previously deducted your medical expenses for psychiatric or psychological treatment, then you generally should not have to pay federal income tax on this portion of your award.
3. Compensation for Lost Income and Lost Earning Capacity
If your personal injury settlement or verdict includes compensation for loss of income, loss of benefits, or loss of future earning capacity, this portion of your award is also likely to be considered non-taxable. The tax code includes special provisions which provide that compensation for lost earnings due to physical injuries are not subject to income taxation.
4. Compensation for Property Damage
Compensation for property damage is generally non-taxable as well. In most cases, as long as you do not receive more than you paid for the damaged property (such as your car, motorcycle or personal items), any compensation intended for the repair or replacement a damaged item is not considered taxable income.
5. Interest and Punitive Damages
If your personal injury award includes any amounts that are designated as interest or punitive damages, these amounts will generally be subject to federal income taxation.
When considering settlement offers and weighing the potential benefits of going to trial, understanding your potential tax liability is critical to making an informed decision. The nature of your claim, your accident-related expenses, your non-settlement-related income and other factors can all influence the final amount you will take home. Your attorney will be able to help you make decisions that are in your best interests, and you should be sure to tell your tax advisor about your personal injury award.
Schedule a Free Consultation at Powell, Powell & Powell, P.A.
If you live in the Fort Walton area and would like to speak with a personal injury lawyer, we encourage you to contact us for a free initial consultation. To discuss your accident in confidence, please call (850) 682-2757 or request an appointment online today.