If you suffer a personal injury and are awarded a settlement for damages, you may be surprised to discover that some of the recovered damages are taxable in California. The Internal Revenue Service (IRS) has determined exactly what qualifies as taxable income. While not all pieces of a settlement are taxable, it’s important to know which parts are so that you can properly prepare your taxes without any surprises or legal issues.
If you are looking for guidance during tax season and trying to figure out whether your settlement is taxable, a personal injury lawyer can help. An attorney can answer any questions you may have, determine whether portions of your personal injury settlement are taxable, and can help you establish what you need to report to the IRS.
What Part of My Settlement is Tax-Free?
Many elements of personal injury settlements are tax-free. However, certain rules could make something taxable in the eyes of the IRS. After you receive a settlement, it is vital that you understand what is taxable and what is not. If you aren’t prepared with this information when you file your taxes, you could end up owing a large amount to the IRS.
Personal Injuries or Illness
One of the more confusing tax-related elements of a personal injury settlement has to do with whether the settlement is related to injuries and illness. Sometimes the compensation you receive is tax-free and sometimes it is taxable. Whether or not you are taxed will depend on whether you’ve taken an itemized deduction for medical expenses in previous years.
If you have not taken an itemized deduction in previous years, then your settlement will not be taxed. If you have recently claimed such deductions, you may have to pay taxes on your settlement. If you’re unsure which avenue you took in previous years, it’s wise to speak with an attorney or tax professional to be certain of what you’ve done in the past.
Certain Non-economic Damages
Non-economic damages (such as mental anguish, emotional distress, and a decrease in quality of life) often come with compensation that is not taxable. Since the valuation of these damages isn’t cut-and-dry, and as they’re not directly related to medical expenses or lost wages, they are often tax-free.
What Part of My Settlement Is Taxable?
While there are quite a few pieces of a settlement that are tax-free, there are other portions of your settlement that will always be taxed. Expecting to be taxed on such income can help you avoid paying penalties to the IRS or the state of California when you file your taxes.
Lost wages are always considered taxable income because the income would have been taxed if you were able to complete your work as expected. All lost wage settlements are subject to the tax rates in effect the year they’re paid. You will need to pay not just federal and state income tax, but also Social Security and Medicare taxes.
If you are awarded compensation for missed work as a self-employed worker, you will have to pay self-employment tax just as you would have if you worked.
Punitive damages are always taxable according to the IRS. This type of income must be filed as “Other Income” on your tax return.
The reason punitive damages are taxable is that they are not directly related to the injuries or losses that took place. Instead, they are given as a means of further punishing a defendant for egregiously breaking a law.
According to the IRS, you must report any interest that you earn from your settlement. Accruing interest on a settlement is uncommon, but if it does happen, you must pay taxes or risk facing a fine.
Special Situations That May Cause You to Pay Taxes on Your Settlement
Some circumstances could cause your settlement to be taxed. These won’t apply to every case. Be sure to check carefully to determine whether they apply to you. Situations that increase the likelihood of paying taxes on your settlement include:
You Added Itemized Deductions for Medical Expenses In Previous Years
While income from a personal injury settlement is generally non-taxable, you will have to pay taxes if you added itemized deductions in previous years. You will be responsible for paying taxes for each year that you listed medical expenses as deductions.
If you had a professional file your taxes in previous years, contact them and find out whether you did this, instead of simply guessing. If you guess wrong, it could cost you a large sum of money.
You Received a Settlement After Witnessing an Injury
In some circumstances, you could be awarded a settlement after suffering mental anguish or a loss of enjoyment of life due to witnessing an injury or a death take place. While these types of non-economic damages are tax-free for injuries that occur to you, when the injury occurs to someone else, you will be taxed on any income that you receive.
If you haven’t previously received a tax benefit for these items, you can reduce the amount you pay toward your taxes based on the amount you paid for doctor and professional visits.
KJT Law Group Can Help Determine Whether Your Settlement is Taxable
If you receive a personal injury settlement, you may have to pay taxes on some of that income. It can help to work with a professional team that has experience with such tax situations to ensure that you do not overpay or underpay your taxes. At KJT Law Group, our team is committed to helping our clients receive the treatment that they deserve. We can work with you to determine which parts of your settlement are taxable and which should be considered tax-free. When you need help with your personal injury settlement taxes in California, reach out online or call (818) 507-8525.