Generally, the amount you receive for your personal injury claim is not taxable under state or federal law. It also does not matter whether you have received the money through negotiations process, or by winning the case at a trial or through mediation. The IRS or the state cannot tax your settlement amount or the proceeds from the verdict. This is pretty rare in this contemporary America where everything seems to be taxed and the taxes are higher as well.
A Rare Occurrence
The amount received should be personal injury damages that can include medical bills, lost wages, pain and suffering, and loss of consortium. The part of the settlement that goes towards paying attorney fees is also not taxed. Your attorney will be grateful for that.
Back to Reality
However, there are certain exceptions to the rule. If you have suffered an illness or physical injury due to breach of contract and such breach is the basis of the lawsuit, then damages are taxable. Additionally, punitive damages awarded by the court will be always taxed.
If you are claiming punitive damages, or there is a chance of the jury awarding punitive damages, your lawyer should ask for separate verdicts for compensatory and punitive damages. This way you can easily prove to the IRS the part of the settlement that is compensatory and non-taxable, and the part that is punitive and taxable. This will make it much easier for your accountant or yourself depending on who normally prepares your taxes.
It may not be a big deal in May buy in March of the next year when you are tackling your taxes for the previous year you will be thanking yourself. The IRS has never been bigger and more eager to collect more revenue because of the nation’s problems. You do not want to be audited.
Physical Injury is the Difference Maker
Even compensatory damages that are non-taxable, pertain only to verdict or settlement of physical injury. If you are claiming compensation for emotional distress or discrimination at workplace, where there is no actual physical injury involved, the verdict or settlement will be taxable. However, if you are able to prove even a little amount of physical injury, you do not have to pay tax.
If you are making two claims, one relating to personal injury, and another that is not, make sure the claim for personal injury is larger. Also, verify that the settlement for personal injury is clearly stated separately in the settlement agreement.