Personal injury clients sometimes ask whether they will have to pay taxes on any compensation recovered in a personal injury claim. The answer is that in most cases, Uncle Sam will not tax the majority of a personal injury settlement.
Personal injury claims are meant to make people who have been injured because of others’ carelessness or recklessness financially whole. At Younce, Vtipil, Baznik & Banks, P.A. we help people who have been seriously injured in accidents through no fault of their own seek full compensation for medical expenses, lost income from missed work, pain and suffering, property damage (such as in a car accident), and more.
In general, the IRS taxes income. But Internal Revenue Code Section 104 exempts certain income derived from lawsuits, settlements, and awards from taxation depending on the reason it was awarded. Specifically exempted are “any damages (other than punitive damages) received … on account of personal physical injuries or physical sickness.”
As your attorneys, Younce, Vtipil, Baznik & Banks, P.A. would work to structure any settlement you were to receive to minimize your tax burden where possible. We also would advise anyone receiving a substantial settlement to consult a tax advisor.
Types of Compensation Recovered in Personal Injury Cases
A personal injury claim may seek three types of compensation for the individual who has been injured:
- Economic damages, which repay the plaintiff for their monetary losses, such as medical bill payments, lost wages while injured, car repair bills, and diminished earning capacity if the injuries impair the plaintiff’s ability to work for a living.
- Noneconomic damages, which the plaintiff may demand for their physical pain, emotional suffering, loss of enjoyment of life, or loss of consortium.
- Punitive damages, compensation meant to deter wanton acts of recklessness and warn others that such behavior will not be tolerated. Punitive damages are only sought in extraordinary cases and are seldom awarded.
The Internal Revenue Service’s general rule is that all income is taxable from whatever source derived unless exempted by another section of the code.
As we’ve seen, the Tax Code does exempt economic and noneconomic damages derived from personal injury lawsuits in most cases. However, punitive damages, if any are awarded, are taxable in North Carolina.
Are Economic Damages Awarded in Personal Injury Claims Taxed?
In general, economic damages demanded in a personal injury claim, also known as “compensatory damages,” are meant to reimburse the plaintiff for their actual expenses and financial losses. Damages due for medical bills and property damage are based on bills and receipts. Because there is no monetary gain, economic damages are not treated as income and therefore are not taxed.
However, a taxpayer may deduct medical expenses from their taxes for the year they occurred. If this deduction is taken in a year prior to receiving a lawsuit settlement or award, all or part of the compensation the taxpayer eventually recovers for medical bills would be taxable.
It might seem like damages paid for lost wages or diminished earning capacity would be taxed as income, but the IRS Code excludes from gross income “the amount of any damages (other than punitive) received … on account of personal physical injuries or physical sickness.” Further, IRS guidance on tax implications of settlements and judgments says, “the Service has consistently held that compensatory damages, including lost wages, received on account of a personal physical injury are excludable from gross income.”
Are Noneconomic Damages Awarded in Personal Injury Claims Taxed?
Noneconomic damages are so named because there’s no specific dollar value for losses due to pain and suffering. They are paid to compensate the plaintiff for unjust physical pain or discomfort, loss of amenities, and mental distress.
When these payments are a direct result of physical injury, they, too, are exempt from taxation. In a guide focused on the treatment of lawsuit settlements and awards proceeds, the IRS considers a typical recovery in a personal injury case to illustrate the usual meaning of “on account of personal injuries” —
Assume that a taxpayer is in an automobile accident, is injured, and, as a result of that injury, suffers (a) medical expenses, (b) lost wages, and (c) pain, suffering, and emotional distress that cannot be measured with precision. If the taxpayer settles a resulting lawsuit for $30,000 (and if the taxpayer has not previously deducted her medical expenses …), the entire $30,000 would be excludable under § 104(a)(2).
The medical expenses for injuries arising out of the accident clearly constitute damages received “on account of personal injuries.” Similarly, the portion of the settlement intended to compensate for pain and suffering constitutes damages “on account of personal injury.”
Interest Payments on Personal Injury Claims are Taxed
North Carolina law requires insurers to pay interest on claims not paid within the statutory time frames. If the case requires going to court, a final settlement or jury award may include an interest payment on compensation the plaintiff should have had sooner.
Any interest paid on a personal injury claim would have to be reported as income and be subject to taxation.
Contact Our Personal Injury Attorneys
At Younce, Vtipil, Baznik & Banks, P.A. we understand that after a serious injury, you may be unsure of where to turn for help and what the implications of a personal injury lawsuit may be. Our attorneys and legal staff are here to help you understand your legal options and how the law applies to your injury. If we believe that you have a valid injury claim, we will be ready to help you pursue compensation through an insurance settlement or lawsuit.