The good news is that personal injury settlements are generally not taxable on the federal level. This means that the IRS will not take any portion of your funds. However, there are a few exceptions to this rule.
When is a personal injury settlement taxable?
A personal injury settlement may be taxable if it includes:
- Punitive damages. Punitive damages are not awarded to compensate the victim for their losses. Instead, punitive damages are awarded to punish the defendant for their wrongdoing and to deter others from engaging in similar behavior. Punitive damages are taxable on both the federal and state levels.
- Interest. Interest on a personal injury settlement is taxable on the federal and state levels.
- Lost wages. If you receive a settlement for lost wages, the portion of the settlement that is attributable to lost wages is taxable on the federal and state levels.
- Medical expenses. If you receive a settlement for medical expenses that you have already deducted on your tax return, the portion of the settlement that is attributable to those medical expenses is taxable on the federal and state levels.
How to avoid paying taxes on your personal injury settlement
There are a few things you can do to avoid paying taxes on your personal injury settlement:
- Set aside money for taxes. If you know that your settlement may be taxable, set aside money to pay the taxes. This will prevent you from being surprised by a large tax bill at the end of the year.
- Work with a tax professional. A tax professional can help you determine which portion of your settlement is taxable and can help you develop a plan to minimize your tax liability.
- Use the money to pay for qualified medical expenses. If you use your settlement money to pay for qualified medical expenses, you may be able to deduct those expenses on your tax return. This can reduce your taxable income and help you avoid paying taxes on your settlement.
If you have received a personal injury settlement, it is important to understand the tax implications of your settlement. While most personal injury settlements are not taxable on the federal level, there are a few exceptions to this rule. It is important to work with a tax professional to determine which portion of your settlement is taxable and to develop a plan to minimize your tax liability.
This article is for general informational purposes only and is not legal advice. Contact us today to discuss your specific situation.
