How Much Tax Is Paid on Lawsuit Settlements?

Dec 01, 2022 | CHASENBOSCOLO

After you’ve been injured in an accident someone else caused, you and your attorney will pursue compensation from the at-fault party’s insurance company. The parties will enter settlement negotiations to resolve the claim. A portion of your settlement compensation may be subject to taxes. The amount of tax you’ll pay depends on the size of the portion of your settlement that’s taxable.

What Is a Settlement?

A settlement is an agreement between parties to resolve an open claim. The at-fault party pays money to the injured party to compensate for the injured party’s losses. In the case of a personal injury case, the money from the settlement agreement is meant to cover the injuries and financial losses the injured person suffered due to the at-fault party’s wrongdoing.

Federal Law on Settlement Monies

Internal Revenue Code (IRC) §61 provides that taxable income includes any “income from whatever source derived” unless it is otherwise exempt within the IRC. This means that any money received for any reason could constitute taxable income unless the IRC provides that it is exempt.

For example, IRC §104 provides that amounts received for personal injuries or sickness are not taxable. This means that compensation for medical expenses linked to an accident will likely not be taxable under the IRC. However, this does not mean that all monies received because of a physical injury or sickness will be tax-exempt, so it is important to itemize the kinds of compensation you receive and the amounts of each when drafting a settlement agreement.

Income Tax on Lost Wages

If your accident-related injury kept you from working and earning wages, you might obtain compensation for those lost wages in your settlement. According to documentation from the IRS, those lost wages are not taxable if the payment was compensation for physical injuries caused by someone else.

Income Tax on Compensation for Economic Losses

Aside from lost wages, you’ll incur other economic losses after an accident caused by someone else. These losses have specific assigned values. Money you receive in a settlement in compensation for these losses is usually not taxable. Economic losses include things like:

  • Medical expenses
  • Modifications to your home
  • Home health care, if required by your injuries
  • Household assistance
  • Assistive devices
  • Property damage

Income Tax on Mental and Emotional Distress Compensation

After you were injured in an accident caused by someone else, you will also likely incur losses without a specific monetary value. These losses are called “non-economic losses,” and they include intangible losses, like pain and suffering. Under IRC §104(a)(2), compensation you recover for mental and emotional distress in a personal injury case is not considered taxable income. That means any portion of your settlement that is specifically identified as non-economic compensation should not be taxable. Non-economic compensation can include money for:

  • Pain and suffering
  • Post-traumatic stress disorder
  • Anxiety
  • Loss of enjoyment of life
  • Depression related to the accident

Income Tax on Punitive Damages

Punitive damages are only awarded by a judge or jury, so you won’t receive punitive damages in a settlement. If your case goes to trial and you are awarded punitive damages, you should know that they are considered taxable income.

However, under IRC §104(c), if you obtain compensation in a wrongful death claim and the court awards punitive damages, that compensation will be excluded from your gross income.

Contact an Experienced Personal Injury Lawyer

While not all personal injury cases settle outside the court system, most claims result in a settlement agreement. If you have been injured in an accident someone else caused, you should contact an experienced Maryland personal injury attorney from CHASENBOSCOLO. Our seasoned attorneys will meet with you to understand the circumstances of your accident and advise you about your legal options.

When you hire us, we will investigate the accident to determine who was at fault for your injuries and losses. We’ll gather all available evidence to prove who was at fault and show the extent of your injuries. We’ll assess the total value of your claim and pursue full and fair compensation for your injuries. We’ll negotiate with the at-fault party’s insurance company to get the best settlement possible, and if that doesn’t work, we can take your case to court. We’ll advise you about how much tax you’re likely to owe on your settlement or award.

We have a reputation for excellent legal representation for our clients. We are always here to fight for your best interests. Contact us at (301) 220-0050 or contact us online for a free consultation today.