A question we receive from our clients all the time is whether a settlement is taxable income. This is an important question to have answered so that you can plan in advance of any potential settlement in order to reduce the tax implications. The good news is that, generally, any settlement for physical injuries or sickness is non-taxable by either the state or federal government and you do not need to include the settlement or judgment proceeds in your income. Publication 4345 (Rev. 4-2015) – Internal Revenue Service. The thought process behind this general rule is that any personal injury settlement is paid, at least in part, to make the injured party whole, and, taxing this compensation would unfairly punish the recovering party.
Compensation for Personal Injuries are Not Taxable
This general rule is also true for any settlement relating to emotional distress or mental anguish that have originated from a personal physical injury or illness. For example, if you were injured as the result of another person’s conduct, and that injury robbed you of your ability to provide for your family the settlement amount attributable to your emotional distress or mental anguish arising from that injury is non-taxable. Conversely, if you receive a settlement for emotional distress that DID NOT originate from a personal physical injury or sickness, a portion of your recovery is taxable.
The IRS also has specific rules about recovery for lost wages/profits and any loss-in-value of property. Specifically, amounts recovered in settlement for lost wages and/or profits are almost always taxable, while, contrarily, any amount recovered for loss-in-value is generally non-taxable.
Make sure that as much of your Settlement as Possible is Non-Taxable
Sometimes you may have two different types of claims against a defendant, one of which relates to a personal injury, non-taxable, and one which does not and, thus, may be taxable. If you have a case like this, you would want to make sure that your attorney drafts any settlement agreement in a way to best limit your potential tax consequences.
If you or someone you know has a potential legal matter, call one of the experienced attorneys at Hipskind & McAninch, LLC, at: 618.641.9189 | 314.242.2930 | firstname.lastname@example.org