Are Personal Injury Settlements Taxable?

benefit claimForbes magazine posted an article about an Illinois man who won a $21.5 million dollar verdict after being struck in the head by a door on a Holland America Cruise ship, leaving him prone to vertigo and seizures.  The reason a business magazine chose to report on this is because $16.5 million of the verdict was awarded for punitive damages, meaning the man will have to pay taxes on that money to the Internal Revenue Service.  As Forbes reports, prior to 1996, all types of personal damages were not subject to taxes.  However, since 1996, only damages awarded for physical injury are tax-free.

To further clarify, the general rule is that any money you receive as the result of a personal injury claim is not subject to state and federal taxes.  This means that the usual personal injury damages meant to compensate for medical bills, lost wages, pain and suffering, loss of consortium, emotional distress, and attorney fees are not taxable as long as they stem from a physical sickness or personal injury caused by the negligence of another.  However, there are three exceptions to this rule:

1)      If the basis of your lawsuit is a breach of contract, and/or it is a breach of contract that causes your injury, you will be taxed on damages.

2)      Punitive damages, which are those damages above and beyond what it would take to compensate the victim, will be taxed.

3)      Interest earned on a verdict is taxable.  Interest occurs if your state’s court system has determined that the victim should earn interest on the verdict for the time the case has been pending.

It can be difficult for a personal injury victim to determine what types of damages are taxable and which are not.  If you want to be sure that as much of your settlement as possible is non-taxable, it is advisable to consult with an experienced personal injury attorney.

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