Will You Have to Pay Income Tax on a Settlement or Verdict?

You’ve been hurt in a motor vehicle accident or in a slip and fall on someone else’s property. You’re considering accepting a settlement to cover your losses or a jury has awarded you damages. Will the settlement or verdict be subject to income taxes? Maybe yes and maybe no. Let’s take a closer look.

The Tax Consequences of a Personal Injury Award

When determining whether a personal injury settlement or jury verdict is potentially taxable, the key question to be asked is “what is the damage award intended to replace?” In a personal injury lawsuit, you can seek damages for:

• Lost wages and income
• Loss of enjoyment of life
• Loss of companionship or consortium
• Physical pain and suffering
• Unreimbursed medical expenses
• Property damage or loss

Damages Recovered for Physical Injury Are Not Taxable

According to the Internal Revenue Code, any compensation that a person receives for physical injury or illness is not subject to taxation, whether it’s in the form of a settlement or a verdict. Furthermore, if your losses are related to a physical injury, they will not be taxable. Therefore, any compensation for the losses specified above, if related to a physical injury, will not be subject to taxation. Compensation for lost wages, loss of companionship, medical expenses, pain and suffering, and loss of enjoyment of life, if stemming from a physical injury, will not be taxable.

Damages for Emotional or Mental Injury Are Subject to Tax

As a general rule, compensation for wholly emotional injuries will be taxable, unless you can show that the emotional distress was caused by a physical injury. For example, if you suffered permanent scarring and disfigurement in a car accident, which caused you embarrassment or humiliation, it may be non-taxable.

Punitive Damages Are Generally Taxable

Because punitive damages are not intended to compensate you for any loss, but rather to punish the wrongdoer, they will typically be subject to income tax.