When Do You Have to Pay Taxes on Your Personal Injury Lawsuit Damages?

January 3, 2021

Any time you get a large financial windfall, it’s smart to put some aside for taxes—but does that apply to personal injury suits, too? Clients often ask when personal injury damages are taxable in Chico, CA, but most don’t even consider it until the tax bill arrives. Knowing what your tax liability may be will help you determine your personal finances, but it will also help you decide whether a settlement offer is acceptable.

Here’s how to determine whether your personal injury settlements are taxable in Chico, CA and what taxes you pay on a personal injury settlement.

Settlements are often non-taxable

For the most part, personal injury settlements are non-taxable. This applies to both insurance claims as well as anything awarded by a judge or jury. Your insurance company usually supplies a 1099 to the IRS, so the government will have a record of how much you received from them—don’t neglect to leave this important information out of your tax return, even though you won’t pay taxes on it.

This, of course, assumes that your injuries are physical. Any damages that stem from physical injury, such as medical expenses, lost wages, loss of consortium, emotional distress, pain and suffering and attorney fees are all passed on to you, tax-free. Physical injury includes all illnesses—anything from broken bones to contracting an illness. If your employer knowingly or negligently exposed you to a severe viral illness, for example, you could recover damages for that physical injury, and it would not be taxed.

Exceptions to the rule

However, there are exceptions of which you should be aware. The major one is that if you did not experience a physical injury or illness, your settlement will be taxed. In 2017, the Trump Administration passed a law that limits tax-free settlements to those stemming from an actual physical injury.

For example, if you sued for emotional distress but did not suffer any sort of physical injury or illness, you will need to pay taxes on whatever you receive. The law prohibits you from claiming insomnia, stomachaches or headaches as physical injuries. Therefore, if your claim arises solely from emotional distress without a physical illness or injury, you will need to pay taxes. This is confusing, because obviously the psychosomatic illnesses that stem from emotional distress can have very real physical results. Unfortunately, however, the illness needs to be more severe before you can elevate it to tax-free status.

Tips to keep your settlement tax-free

Depending on how many claims you have against the defendant, it’s worth noting which settlement damages specifically pertain to physical illness or otherwise. This will help keep your damages as tax-free as possible, which maximizes your recovery.

Talk to your lawyer about what you can do to ensure you get to keep as much of your settlement money as possible. It’s particularly important when you’ve deducted medical bills to keep your tax liability low.

For more information about taxable personal injury settlements in Chico, CA, call The Law Offices of Max G. Arnold, Inc. today.

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