Are Personal Injury Settlements Taxable?
Whether you received injuries from a car accident, personal injury, medical malpractice, or the wrongful act of someone else, the time immediately afterward is stressful. You must worry about your recovery as well as how you will pay your medical bills – especially if you missed wages due to your injury. Your settlement will provide relief from the burden of worrying about your medical bills and lost wages. However, how much of your settlement is taxable?
Does the Federal Government Tax Personal Injury Settlements?
For the most part, the federal government does not tax personal injury settlements. Most portions of a personal injury settlement, such as payment of medical bills, compensation for lost wages, and damages for pain and suffering, constitute reparations for the damages you suffered as a result of the injury. Compensation for these damages aids you in recovering from your injuries, repairing your life, and making it whole again.
Thus, the federal government does not consider most personal injury settlement funds income and will not impose taxes on most portions of your settlement. The ruling holds true whether the compensation comes in a lump sum, a monthly payment, or some other payment plan. As always, however, there are exceptions to the policy, most of which deal with settlement funds over and above the amount awarded to cover your physical, financial, and emotional damages.
The first exception deals with emotional distress. It is important to determine the origin of the distress – is associated with a physical injury and awarded alongside damages for medical bills, pain, and suffering, and lost wages, the government will not tax emotional distress damages. However, if your emotional distress resulted from a purely non-physical incident, such as a hostile workplace, the emotional distress damages are taxable.
Another exception involves punitive damages. Regardless of the situation that led to your claim, any punitive damages awarded are over and above the amount necessary to address your physical and financial damages. As a result, punitive damages are income subject to federal taxes. The government taxes portions of wrongful death damage settlements as well, including punitive damages and compensation for the deceased person’s lost wages and profits.
Finally, tax exceptions may apply to interest and deductions from personal injury settlements. If a judge awards you a settlement with interest, federal taxes apply to the interest portion only. Similarly, if you took a deduction last year for the cost of your medical bills, you may not take the deduction again this year and must report on this year’s taxes that you received compensation for the expenses.
Massachusetts State Taxes
Massachusetts, like the federal government, imposes taxes on punitive damages and emotional damages not related to physical injury. Similarly, settlements awarded with prejudgment interest are subject to Massachusetts state tax. The state taxes prejudgment interest at a rate of one percent per month.
Wrongful death settlements prove particularly tricky in Massachusetts. If you received a wrongful death settlement awarded directly to you or other family members, the state will not tax the settlement. However, if the judge awards the settlement to the deceased person’s estate and begins the state’s probate process, the state will assess inheritance taxes.
Consult an Attorney or Tax Professional
Although settlements may provide financial relief from the burden of medical bills and lost wages, stress at tax time is a real concern for many people who received settlements in the past tax year. If you are unsure whether the IRS or the state of Massachusetts will tax portions of your personal injury settlement, or if you wish to minimize your tax burden, speak to a personal injury attorney or tax professional. Tax time does not have to be difficult, even when you are dealing with a large settlement, and consulting a professional will help you take your first steps with confidence this tax season.