Tax season is almost upon us, and if you’re expecting a settlement it’s smart to be worried about whether or not you need to report your winnings to Uncle Sam. You won’t have to worry about state taxes in Tennessee: the fact that we don’t have income tax keeps you from having to worry about paying the state any portion of your personal injury settlement.
Tax law is complicated, and it doesn’t get any simpler when settlements are involved. The short answer is that some parts of your award are taxable, and some parts aren’t.
Physical damages aren’t taxable. The IRS recognizes a lot of that money is going to the hospitals and specialists anyway. You don’t even have to report this portion of your settlement.
Physical damages also includes pain and suffering, emotional distress, or loss of consortium, as long as your emotional distress award was related to your physical injury. There are some cases, like a libel suit, where you could receive an emotional injury award without the involvement of a physical injury. In a case like that, your winnings would be taxable.
Note that the IRS states that symptoms like insomnia, headaches, and stomachaches count as “emotional” symptoms rather than physical symptoms. If these are your only ailments your settlement may still be taxable, even though you are feeling the effects in your body.
It’s a little confusing, because the cause (physical injury vs. emotional distress) of a physical ailment or emotional ailment matters more than the end result does.
In a strict personal injury case lost wages are not taxable: you’re in the clear if you were injured in a car accident, truck accident, or motorcycle accident. This would also cover lost wages from a premises liability or product defect suit.
Lost wages are taxable in some other suits, especially employment lawsuits where you’re suing for discrimination or unlawful termination.
Both physical damages and lost wages are known as “compensatory damages.” Grouping them this way can make it easier to remember what is and isn’t taxable as this is how the court will divide them out as well.
Punitive damages can be a lucrative source of income for some personal injury victims, as the amount awarded can go well beyond what your actual costs are in the suit. These damages are taxable by the IRS.
You do have to report income from punitive damages.
Your settlement may earn interest as you wait to collect it. The interest is taxable. You get a little extra for having to wait, but the government still gets its portion of that extra bit.
You of course do not have to pay taxes on any monies you have not actually received yet.
Minimizing Tax Liability
Tax liability can create serious issues for families who are already suffering. Hire an attorney who understands the tax considerations and who takes them into account when structuring your settlement. Even making certain claims can make a difference. Sometimes things you claimed, but didn’t prove, can give you the right to claim tax exemptions later.
You should also consider hiring an accountant who can help you both reduce your tax liability and navigate parts of a complicated tax code you’ve never had to deal with before.