Is My Personal Injury Settlement Taxable?

One thing you need to know when you receive an offer to settle your personal injury claim is how much of that money will actually make its way into your pocket. As with everything else, taxes can be an issue. There is no simple yes or no answer to the question: is my personal injury settlement taxable?

You will want to talk to a Maryland personal injury attorney about whether there are ways to minimize the taxes on your personal injury settlement. Sometimes, the language of the settlement agreement can affect whether some portions of the settlement are taxable.

The General Rule About Taxes on Personal Injury Settlements

The rule of thumb is that you do not have to include personal injury settlements in your gross income on your tax return, whether you receive a lump sum or periodic payments. The reality, however, is that certain categories of money damages are taxable. 

In Maryland, compensatory damages are not subject to state or federal income taxation. One example of compensatory damages is recovering the reasonable cost of the medical treatment a person needed for their injuries. It would be grossly unfair for the government to make money off of people getting hurt due to the negligence of others. 

Another type of compensatory damages is money the plaintiff receives for their pain and suffering, disfigurement, ongoing disability from their injuries, and loss of enjoyment of life. Again, it would violate public policy for the state of Maryland or the federal government to make money off of the suffering of innocent people. Therefore, the damages for these losses are not taxable. However, compensatory damages for lost wages are possibly subject to taxation depending on the circumstances involved. Therefore, it is important to consult with an attorney who can advise you on the best way to settle your claim.

Often, the settlement agreement and other paperwork involved in settling the personal injury claim does not itemize the dollar amount attributed to each category of losses. In other words, the settlement agreement is unlikely to say how many dollars are for medical bills and how much of the settlement is for pain and suffering or inconvenience. If, however, the settlement includes an award of punitive damages, that portion of the settlement could be taxable.

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

This situation is quite rare, for two reasons. One, an award of punitive damages is rare in a personal injury case because of the extraordinary factors required to justify awarding punitive damages. The plaintiff has to provide evidence that proves the defendant acted outrageously, with malice, or for some other reason that would be “shocking to the conscience” of the judge or jury. 

Also, punitive damages in settlements, as opposed to jury verdicts, are uncommon. If a case settles out of court, the defendant usually does not agree to pay punitive damages because they would be admitting shockingly wrongful conduct. Usually, punitive damages are only the result of a trial.

A person who receives an award of punitive damages from a court, however, will want to know if that amount is taxable. The Internal Revenue Service (IRS) in IRC Section 104(a)(2) says that proceeds received from a personal injury claim, whether by settlement or a court award, are not taxable, except for the punitive damages portion. A plaintiff who receives an award of punitive damages from taking the case to trial or by settling out of court will have to include the punitive damages in their gross income on their tax return. A Maryland personal injury attorney can talk to you about your personal injury claim and handle your case so that you can focus on getting better. Contact our office today for legal help, we gladly offer a free consultation.