Do I Have to Pay Taxes on my Personal Injury Settlement?

Once you receive an award or settlement for your personal injury claim – whether it be from a third party insurance company or your own – your top priority will most likely be to pay off your bills and work toward getting your life back in order. Medical bills and regular everyday expenses can add up when you’re injured, so it’s understandable that getting those expenses taken care of and paid for is one of the top priorities for recovering accident victims.

Being a personal injury law firm, we at Seattle-based Davis Law Group, P.S., see our clients to this point of their lives over and over. After months or even years of waiting for their case to be completed, our clients are typically very eager to cash their settlement checks and move on with their lives. But often during this process a client will pause for a moment and ask, “Do I have to pay taxes on my personal injury award?”

Is There A Personal Injury or Illness Tax?

If you receive a settlement or verdict award that is deemed as compensation for physical injury or illness, that money is not subject to federal income tax. That's regardless of whether the compensation was received via a court-ordered award or a settlement that was negotiated out of court. It makes no difference if the compensation is in a lump sum or spread out through multiple installments.

If you receive compensation for medical expenses, that money is also considered tax-free. However, if the victim claims a medical expense deduction for medical costs that are later reimbursed in a personal injury award, then the deducted amount must be reported as income on his or her tax return.

Compensation for lost wages, interestingly enough, is also considered non-taxable, despite the fact that those wages would have been subject to income tax if they had been earned through the course of employment. But if any of the compensation is considered interest for the delay between the victim’s injuries and the time that they receive compensation, then that portion is considered taxable.

Additional Compensation Can Be Taxed

Compensation for legal injuries – i.e. harassment, discrimination, etc. – is subject to tax, as is compensation for emotional distress that did not result from personal injury or illness. That also goes for punitive damages – even if they are considered compensation for a person’s physical injury or sickness. This is a bit of a moot point though, since punitive damages are not allowed in Washington state.

If you incur legal expenses for attorney fees and other costs, you are not allowed to deduct those expenses on your tax return. It’s a fair rule, considering that the compensation you receive for a personal injury award is generally non-taxable.

This is important information for accident victims because many people assume that once they receive their settlement or award that the personal injury case is done and over with. Gaining a solid understanding of how the tax laws affect your personal injury compensation can help you avoid financial headaches in the future. For more information about tax rules related to damages awards, visit the IRS website and check out IRS Publication 525 – Taxable and Nontaxable Income.