When you win or settle a personal injury claim, one question often comes to mind: Are the financial damages received taxable? That is a great question, and the answer depends on the nature of the compensation you receive and the type of loss it is meant to address.  Let’s start by looking at the type of damages you could get.

What Types of Damages Can I Receive in a Personal Injury Claim?

Personal injury damages can generally be grouped into two main categories: compensatory damages and punitive damages. Compensatory damages are intended to make the injured party whole again by covering various losses such as medical expenses, lost wages, and pain and suffering.

Punitive damages are awarded in rare cases where the defendant’s conduct was particularly reckless or malicious and are intended to punish the defendant rather than compensate the plaintiff.

Are Compensatory Damages Taxable?

The general rule is that compensatory damages for physical injuries or physical sickness are not considered taxable income. The IRS does not treat these payments as taxable because they are intended to reimburse you for losses directly related to the injury.

• Medical Expenses: If the damages received are specifically for medical expenses related to your injury or illness, they are not taxed. However, if you deducted those medical expenses on your tax return in previous years, you may be required to include the reimbursement as taxable income.
• Lost Wages: Compensation for lost wages due to your injury may be subject to tax. Since wages would have been taxed if earned, any compensation replacing that income is also taxable.
• Pain and Suffering: If the pain and suffering damages are directly related to a physical injury, they are generally non-taxable. However, pain and suffering damages not tied to a physical injury (such as damages awarded in cases of emotional distress without a physical component) may be subject to tax.

Are Punitive Damages Taxable?

Yes, punitive damages are always taxable, regardless of the nature of the injury. The IRS considers these damages as additional income because they are not intended to compensate you for a loss but rather to punish the defendant for their behavior. You will need to report these damages as “Other Income” on your tax return.

Are Emotional Distress and Mental Anguish Damages Taxable?

Damages for emotional distress or mental anguish may be taxable depending on the circumstances. These damages are generally non-taxable if they stem from a physical injury or sickness. However, the damages may be taxable if emotional distress is unrelated to a physical injury, such as in cases of discrimination or defamation.

How Do Structured Settlements Affect Taxability?

A structured settlement spreads out the payment of your damages over time rather than providing a lump sum. The taxability of each payment depends on what it compensates for.

Generally, structured settlement payments for physical injury or sickness are tax-free. However, if the payments include punitive damages or interest, that portion will still be taxable.

Do I Need to Report the Settlement on My Tax Return?

Whether you need to report the settlement depends on the nature of the damages. For non-taxable damages, such as medical expenses related to a physical injury, you do not need to report the settlement. However, your tax return must include taxable portions such as lost wages, punitive damages, or interest.

The Fayetteville Personal Injury Lawyers at Osborne & Wilmoth Law Firm Can Guide You Through the Settlement Process

If you have questions about how your personal injury settlement may impact your taxes or need help understanding your rights, the experienced Fayetteville personal injury lawyers at Osborne & Wilmoth Law Firm are here to assist. For a free consultation, call our Fayetteville, Arkansas, office at 479-521-7727 or complete our online form. We also serve clients in the surrounding areas.