When you are injured in an accident or some other situation caused by someone else's negligent (or even intentional) conduct, any successful legal claim you make will typically include compensation for a variety of losses (called "damages"), including pain and suffering, lost wages, mental anguish and emotional trauma, and medical bills. And, if the responsible party's conduct was particularly egregious, you may even have a claim for punitive damages.
What's more, if your claim proceeds to a personal injury lawsuit, a trial is held, and you obtain a judgment, there will likely be interest added to that judgment, from the date your suit was brought until the date the judgment is paid.
As you can see, there are many components to the financial side of a personal injury claim. Over time, the IRS has addressed the taxable status of various kinds of damages awarded in personal injury cases and has determined that some are taxable while others are not. While exceptions to the general rules exist (with the tax code, it's always essential to read the fine print), this article lays out the taxable status of the most common components of a personal injury settlement or judgment.
Pain and Suffering. If you sustained physical injuries in the accident, such as a broken leg and pelvis, the award you receive for your pain and suffering, discomfort, and related negative effects of those physical injuries is non-taxable.
Lost Wages. If your injuries caused you to miss work for a period of time, the award you receive for your lost wages is taxable. This includes any state income taxes, federal income taxes, and other applicable withholding that would ordinarily be deducted from your pay. This is fairly logical, since your employer would have withheld these amounts if you had received a paycheck.
Mental Anguish and Emotional Trauma. Apart from the physical pain and suffering that you experience from your injuries, you may also suffer psychological effects such as mental anguish and emotional trauma. For example, you may develop post-traumatic stress disorder ("PTSD") as a result of a particularly serious accident. Whether damages awarded for these psychological injuries are taxable depends on whether they originate from a physical injury; if they do, they are non-taxable, but if they do not they are taxable. So, if your PTSD resulted from a horrific car accident in which you sustained multiple spinal fractures, your award for mental anguish and emotional trauma would be non-taxable. However, if your PTSD arose from a blogger's defamatory articles about you, causing no physical injury, you would have to pay taxes on your mental anguish and emotional trauma damages award.
Medical Expenses. A settlement or award meant to compensate you for medical bills in a personal injury case is non-taxable. However, it's important to note that if you have deducted these medical expenses on a prior year's tax return, the amount of that deduction will be deemed taxable income to you.
Punitive Damages. If the responsible party's conduct in causing the accident was grossly negligent or intentional, you may have a claim for punitive damages. These damages are designed to punish the wrongdoer for his/her bad conduct and are not meant to compensate you for your injuries or losses. While some exceptions may apply, the general rule is that punitive damage awards are taxable.
Interest. When your personal injury claim cannot be settled, and the lawsuit goes to trial, a money judgment in your favor will typically include an interest component that adds on to the judgment amount, starting from the date the case is filed and continuing until the date the judgment is fully paid. The interest awarded on a personal injury judgment is taxable.
As you can see, there are a number of moving parts when it comes to the potential tax consequences of filing a personal injury claim. Once you receive a settlement or judgment, it may make sense to consult with a tax professional to make sure you understand your rights and obligations.
