People who suffer a personal injury have a lot to manage, and their lives may be impacted for many years. One issue that may not cross their minds is whether personal injury settlements are taxable. The tax codes of both Nevada and the United States are complex and change frequently, but parts of your settlement may indeed be taxable.
How the Structure of the Settlement Impacts Taxability
Many times, a settlement contains payments for different reasons, including lost wages, medical expenses, your pain and suffering, emotional distress, interest, property damage, and punitive damages assessed to punish the defendant. The structure of your settlement might consist of only one or two payment types, but your settlement could also consist of all of them. The reason behind the payment is the primary factor in determining taxability.
- The portion of the settlement covering your lost wages is taxable because the earnings you would have received from your employer would have been taxable. One complication that can arise is when you receive compensation for the loss of several years of earnings. For example, you might receive the equivalent of four years of salary in your settlement. All of this will be taxable income for the year in which you receive the settlement, and this could push you into a higher tax bracket.
- If you are self-employed and receive compensation for the profits or earnings you lost, you may also be required to pay the self-employment tax on the proceeds from your settlement.
- The portion of the settlement covering your medical expenses is not taxable. However, if you deducted any of these expenses when you filed your taxes in previous years, the amount you deducted becomes taxable.
- The portion of your settlement covering your pain and suffering is not taxable if a physical injury was the cause. However, if it is considered emotional distress that is not related to a physical injury, it becomes taxable. For example, if you suffered no physical injury in a car accident, but the accident caused you to develop an overwhelming aversion to driving, compensation for this is taxable. However, if your aversion resulted from an injury sustained in the accident, your compensation would not be taxable. Payments for emotional distress are taxable even if the emotional distress causes headaches, insomnia, nausea, or other physical symptoms.
- Compensation to repair or replace your property is not taxable if the settlement is equal to or less than the value of the property. However, if the settlement amount exceeds the value, the excess amount is taxable.
- Interest you receive as part of a settlement is taxable and should be reported as interest income on your tax return. Usually, interest payments are awarded when a claim has been pending for an extended period and are based on the amount of the award.
- Any compensation you receive that is classified as punitive damages is taxable. It does not matter whether the punitive damages are included in a settlement for a physical injury, property damage or emotional distress. For example, suppose you are awarded $100,000 to compensate you for your pain and suffering related to your physical injury and an additional $500,000 in punitive damages. The $100,000 you receive would not be taxable, but the $500,000 would be taxable.
- If your injury was caused by the defendant’s breach of contract, the settlement could be taxable. Your claim must be based on the breach of contract. However, contract breaches rarely appear in personal injury cases.
How to Minimize Taxes on a Personal Injury Settlement
Your personal injury attorney or tax accountant can offer suggestions on ways to legally reduce your tax liability. There are various strategies that may help. Here are just two possibilities.
- Discuss the possibility of a structured settlement with your attorney. A structured settlement is paid over more than one year. Instead of owing taxes on a large settlement during a single year, you would spread the taxes as well as the income over multiple years. This may help you reduce your taxes on payments for interest income, punitive damages, emotional distress or future lost wages.
- Discuss the classification of damages with your attorney. Some types of damages are easier to quantify than others. For example, property damage or medical expenses are normally straightforward. However, some types of damage are rather subjective, and how they are classified could affect their taxability.
At Powerhouse Injury Attorneys, we focus our practice on matters related to personal injury law. Our attorneys have experience in litigating cases as well as in negotiating settlements. We will strive to obtain a settlement for you that may reduce your concerns over taxes. We offer free case consultations, so call 702-444-2222 or contact us online to schedule a meeting with one of our experienced attorneys.