Is My Personal Injury Settlement Taxable?

You might be wondering if a personal injury settlement you or a loved one received in Nevada is taxable. The good news is that, according to IRS regulations, settlements from personal injury lawsuits are typically not taxable. There are a few exceptions to this rule, though.

Understanding the tax implications of receiving any personal injury settlement is crucial, but figuring out which portions of your settlement are exempt from taxes can be challenging. Different laws apply in a variety of personal injury circumstances. You need to consider every type of payment you get from the settlement because understanding how your taxes will be affected by each of them is crucial for your financial future.

Below, we explain the IRS regulations governing personal injury lawsuits, the types of taxable settlements, and how to minimize your taxes on a personal injury settlement. It’s important that you speak with a tax expert to ensure you comply with IRS rules and maximize tax savings.

What Is a Personal Injury Lawsuit Settlement?

A personal injury lawsuit settlement is an agreement between a plaintiff and a defendant in which the defendant agrees to pay the plaintiff, or injured person, a sum of money in exchange for the plaintiff’s release or waiver of all claims against the defendant. Personal injury settlements can be reached at any stage of the legal process, but they are most frequently reached before the trial. This is because settling out of court saves both parties time and money.

The amount of compensation received in a personal injury settlement is based on several factors, such as the seriousness of the injury, the cost of medical care, the amount of lost wages, and how much pain and suffering the injured party has endured. It’s important to note that accepting a settlement offer means giving up the right to pursue additional legal action related to the injury. Therefore, it’s essential for the injured party to carefully consider the terms of the settlement before accepting them and to speak with a knowledgeable personal injury attorney.

What Are the IRS Guidelines for Personal Injury Settlements?

Are case settlements taxable?

To determine whether payments are taxable or not, the IRS divides lawsuit awards and settlements into two distinct categories. Claims relating to physical sickness and injuries fall under the first group, while claims relating to nonphysical injuries fall under the second. Payments from the first category are generally nontaxable, whereas payments from the second one are typically taxable. However, depending on the specific circumstances of each case, there may be exceptions.

The IRS considers compensation for physical injuries and physical sickness as a “personal injury” and exempt from taxation. This includes:

  • Physical injury: Payments from personal injury claims, such as car accidents, slip and fall injuries, or wrongful death lawsuits.
  • Physical sickness: Settlements related to physical symptoms, such as chemical and hazardous exposure, that cause chronic illnesses like cancer or emphysema.
  • Emotional distress: Payouts for emotional distress, sometimes called pain and suffering, if attributed to physical injury or sickness. This also includes damages for defamation and humiliation.
  • Medical expenses: Compensation for medical expenses and workers’ compensation related to your physical injuries and sickness unless you previously deducted those expenses from your taxes.
  • Lost wages: Settlements for lost wages attributed to physical sickness or injury.

What Are the Exceptions to the Rule That Personal Injury Lawsuit Settlements Are Not Taxable?

Settlements for personal injuries frequently include various forms of compensation or allocations. Not all forms of payment are deemed tax-exempt, as they are not all related to actual physical illnesses or injuries. Allocations included in the “nonphysical injuries” category are the most frequent exceptions to the general rule that personal injury settlements are not taxable. Nonphysical injuries include:

  • Damages for emotional distress and anguish not caused by physical injury/sickness.
  • Employment-related lawsuit settlements, including discrimination and wrongful termination.
  • Damages received to compensate for economic loss, such as lost wages, dismissal or severance pay, or lost profits from your business.
  • Any interest earned on your settlement.
  • Any medical expenses already deducted from your taxes. Since you’ve already claimed the tax benefit, these expenses will be treated as income.

What About Punitive Damages?

Punitive damages are awarded to punish the defendant for their actions and are not considered compensation for your injuries. Although punitive damages may be awarded as part of your physical injury settlement, they are taxable.

How Can You Minimize Your Tax Liabilities With a Personal Injury Settlement?

The tax ramifications of a personal injury settlement can have far-reaching effects, so it’s essential to make a careful assessment when determining your tax liability and filing procedures when you receive compensation. Here are a few steps you can take to minimize your tax liability on a personal injury settlement:

  • Consult a tax adviser or lawyer who focuses on personal injury settlements as your first step to ensure you understand your settlement’s tax implications, are taking full advantage of all tax-saving opportunities, and file your taxes correctly.
  • Consider using a structured settlement, where you receive your settlement payments in installments over a certain period rather than in a lump sum. Structuring your settlement carefully can help you spread your income over the years and reduce your tax liability.
  • Think about investing some of your settlement in a tax-advantaged investment, such as a Roth IRA, that reduces your tax liability while growing your income tax-free for use in your retirement.

These are just a few things you can do to reduce your tax liabilities when you receive a personal injury settlement, but it’s important to remember that tax laws are complex and subject to frequent change. Always seek tax advice from an experienced tax professional or attorney.

Find Out if Your Settlement Is Taxable

Contact the experienced staff at De Castroverde Accident & Injury Lawyers for assistance if you have questions about your personal injury claim, including the tax repercussions of your settlement, how we can represent you in settlement negotiations, or how we are paid from a settlement. Our knowledgeable personal injury lawyers have been assisting Las Vegas residents with navigating the legal system and defending their rights since 2005.