When you’re successful in recovering money from your personal injury claim, it’s a great feeling knowing you won’t sink into debt after a negligent person caused you harm. You’ll be able to cover all those medical bills and other expenses while making up for your lost income.
You may have received compensation for noneconomic damages such as your mental anguish or pain and suffering. While it’s certainly a victory, there’s something important you should know about personal injury settlement taxes.
You may need to pay tax on some of the amount you were awarded. Fortunately, many damages you’ll receive are not considered taxable income either under Pennsylvania state law or federal law. However, there are exceptions that you should be aware of to prevent any surprises during tax time.
Which Types of Personal Injury Compensation Are Subject to Taxes?
It’s important to know which types of personal injury compensation are considered taxable earnings. In general, these are the damages that require the payment of taxes.
Receiving compensation for your wages means that you will have to pay taxes on it. When you are awarded for lost wages, you will need to deduct the taxes that would have been taken out if it had come in the form of a paycheck. Since you’d be taxed on your wages had you been able to work for them, lost income is a taxable part of your settlement.
If you have been awarded interest in your settlement, it is also taxable. This works in the same way that your savings account interest earnings generate more income for you.
Emotional distress or mental anguish awards could be subject to taxation. You’ll want to consult both your attorney and a tax expert for advice if this was part of your settlement and it wasn’t related to any physical injuries or illnesses.
Other Potentially Taxable Portions of Your Personal Injury Settlement
You may additionally need to plan on paying taxes for your attorney’s fees if they were included in your judgment. These fees may be tax-deductible though if your attorney is paid separately from your settlement.
In some cases, medical bills may also be taxed. If some of your settlement is for these bills and you made deductions on it in previous years, then you may owe taxes.
When punitive damages are awarded, these are taxable at the federal level. It is recommended that you work with a tax professional to ensure that you pay taxes on the appropriate portions of your settlement.
Which Types of Personal Injury Compensation Are Not Subject to Taxes?
While some of your settlement or judgment will be taxable, much of it will be exempt from taxation.
Medical expenses are generally not taxable if you do not take any deductions on your tax returns for injury-related expenses. It’s always best to err on the side of caution and work with an accountant who can keep you from making a mistake.
Property damages are generally not taxable income either. The exception is if the amount you receive is greater than the property’s adjusted basis, which would require you to pay taxes on the amount in excess.
Pain and Suffering
Most noneconomic damages are not taxable. There may be situations where emotional distress awards are taxed, though talking with experts about your circumstances can shed more light on what you need to do. Generally, the compensation awarded for pain and suffering along with other noneconomic losses related to physical illnesses or injuries will not be taxable.
How to Reduce Your Tax Obligations on Your Settlement
You may be able to lower your tax obligations in situations involving personal injury cases. Structured settlements may be the right choice, allowing you to receive payments from your settlement over time instead of getting them all at once in a lump sum.Structured settlements may not be the answer in every situation, though it’s worth discussing this option with your Pittsburgh legal advocate for injuries. Since it can help you avoid incurring a massive tax bill all in one year and can provide income that continues to come in with regularity, you should find out if it’s the best way for you to handle taxable income from your settlement.