Will I Have to Pay Tax on My Settlement?

The taxman. He’s seemingly everywhere. Whether it’s your income, a gift, or the lottery, it seems as though the government always gets a piece of your money. But is Uncle Sam entitled to some of the money that you win from a personal injury lawsuit? In a perfect world, you would simply win your lawsuit, collect your money, and be on your way.

When Will You Pay Tax on Your Settlement?

However, it’s never that simple. While there are times that you are not required to pay tax on your settlement, there are also cases in which you will be required to fork over a percentage. As long as you know your way around the law, you can minimize how much you have to pay in the end.

Will You Pay Tax on your settlement?


In Court for Personal Injury?

If you’re in court and suing for a personal injury, the general rule is that you are not responsible for paying taxes if you win your lawsuit. Whether you settle your case beforehand, settle halfway through, or take the trial all the way to a verdict, you do not have to pay taxes on your settlement. This includes both the federal and the state government, no matter where you are in the country. The federal tax law states that money received due to physical injuries is not included in your income for the year.

To be clear, this includes personal injury damages that are meant to make up for things like lost wages, medical bills, emotional distress, pain and suffering, loss of consortium, and attorney fees. None of these are taxable as long as they come from a personal injury or illness. A physical illness, for example, would cover you if you were exposed to a germ or bacteria that made you sick and caused you to miss time from work.

Are There Exceptions?

car crash settlement scenarioAs always, there are exceptions to the general rule. Take a breach of contract case, for example. If you were to take a case to court in which you were suing for an injury or illness caused by a breach of contract (and the breach of contract is the basis of your lawsuit), you will then be responsible for paying taxes on whatever your settlement ends up being.

Furthermore, any money that you receive from punitive damages is always taxable. If your lawyer knows what they are doing, they will request that the judge split your settlement into two different categories: punitive and compensatory. This allows you to show the IRS exactly what money you were rewarded as part of a punitive claim and what you were rewarded as part of a compensatory claim. You can then pay tax just on the punitive claim.

Finally, there is the case in which you pay taxes on interest accrued on the judgment. For cases that have been pending, most states have laws that will add interest to the settlement for as long as the case has been pending. For example, imagine that you file your case on January 1, 2013. Interest on your settlement begins to accrue that day. If the defendant doesn’t end up paying until January 1, 2015, you will receive two years worth of interest on that settlement. However, all of the interest that you receive is taxable.

Get the Most Out of Your Settlement

If you’re at the point where you’re willing to take your case to court, you likely want to get as much money out of the case as possible. Understanding the different tax implications on different types of lawsuits ensures that you end up with as much money in your pocket as possible.

To do this, you may even want to go as far as opening up two different cases against the defendant: one personal injury case and one non-personal injury case. This will make it easier to clearly tell the IRS which settlement can be taxed and which cannot. Although the IRS still has the option to challenge what can or cannot be taxed, this is the clearest path to having as little of your settlement taxed as possible.

As always, it’s important to have in-depth discussions with your attorney about your case to ensure that everything goes well. If you or someone that you know has experienced losses due to the actions of another person or company, contact Solnick Law at (786) 629-6530 for a consultation today, and we will work our hardest to preserve and protect your rights as a citizen of the United States.