After The Courtroom Settlement: Do You Need To Pay Taxes On Your Compensations?
Posted on: 14 November 2014
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It's great news when you receive a settlement from a judge in your personal injury case, as you've likely been through a long process to get to that point. After the stress of the courtroom proceedings ends, many individuals start to ask themselves new questions regarding the money won in the settlement that they hadn't considered before: "Is the settlement money I've been awarded taxable?" "If awarded punitive damages, should I be paying taxes on that sum?" "How does lost income that has been restored and replaced as a result of this settlement factor into things?" Since avoiding taxes (even accidentally) is certainly not something you want to deal with, answering these questions is extremely important. Continue reading to learn more about if your compensation may be taxable--and what steps you should take next:
Understanding the Tax Law
Many individuals question whether there's any difference between a settlement made in court or money obtained in a judgement made after the trial-- when it comes to taxes, there really is no difference. The question of if you need to pay taxes on your newfound money can be found in the type of personal injury case you filed, not the way that the money was obtained.
The law according to the Internal Revenue Service makes it clear that any settlements as a result of "personal physical injuries" or "emotional distress" are exempt from taxes. This is good news for most individuals with personal injury settlements, as those two statements encapsulate the majority of cases that have been won.
Taxes on Lost Income
In many situations, physical injuries related to the lawsuit have kept the defendant from wages that they would have normally obtained if the accident hadn't occurred. When a judge awards this lost income, the complete sum is taxable by the Internal Revenue Service. The reason that this differs from the other money obtained from the settlement is simple: since you would have earned this money from normal work but are being reimbursed for lost wages, the income is treated as normal and taxed as your normal paycheck would be taxed.
​Dealing with Punitive Damages
In some circumstances, the judge may award punitive damages to you based upon the situation of your case. Money obtained from punitive damage awards is almost always taxable--if you are receiving the cash as a result of a nonphysical injury (anything that can not be filed under physical damage), you'll likely need to pay the tax.