Dealing with a car accident is probably one of the most stressful times in a persons life.
In this article we explain how the process works when it comes to paying taxes to the IRS on your settlement.
How much tax do you pay on a personal injury settlement?
Do you have to pay taxes on a pain and suffering settlement?
Can IRS take my personal injury settlement?
Physical injuries and physical sickness?
It’s Not Too Late, Get Legal Advice From Daniel Kim Law Office
If you are dealing with a personal injury case then it is a wise idea to contact Daniel Kim today and get answers to your questions about the tax laws.
Don’t just hope for the best and accept any settlement.
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How Much Tax Do You Pay On a Personal Injury Settlement?
A personal injury settlement can be taxable, nontaxable, or just partially taxable.
This all will depend on the type of case and the type of compensation for the injuries suffered.
Typically the taxable status of a PI (personal injury) settlement will depend on whether or not there was a “physical injury or physical sickness.”
We have put together this article to help you understand all the complexities because the IRS has established several broad guidelines.
And there is still much dispute as to what specific injuries are taxable.
Are Legal Settlements Taxable
Up until 1996 most personal injury settlements (whether physical or emotional injuries) were tax free.
Nowadays the current laws are much more restrictive.
Generally physical injuries and physical sickness are non-taxable.
For example Jason Jones is injured by a defective chainsaw and ends up with almost $20,000 in medical expenses.
The chainsaw company willingly settles with Jason for $20k.
This personal injury settlement will be tax-free and Jason will not have to report it on a tax return.
Like most legal situations there are always exceptions, and if Jason deducted the $20,000 in medical expenses in a prior tax return, then the settlement will be taxable.
When a PI settlement with a monetary award is based partially on mental anguish or emotional distress it might be tax free.
If the mental anguish or emotional distress is directly related to a physical injury then it is considered to be “medical” and would be non-taxable.
As you can see this tax related information is very complicated so your best bet is to call Daniel Kim Law Offices today.
Can IRS Take My Personal Injury Settlement?
As we all know the IRS loves to get paid when you get paid.
Paying taxes is just something you have to deal with living in California.
Read more below to better understand how the IRS looks at money you get from a personal injury settlement.
The amount that is received in a personal injury settlement which is attributed to interest is typically taxable.
Lost wages or lost income
A financial settlement awarded with compensation for lost wages or loss of income is taxable and needs to be reported on a tax return.
An injured person might be awarded money that goes above the normal compensation for injuries and is meant to punish the guilty person (or defendant).
Punitive damages are generally taxable.
Of course there are exceptions, but it doesn’t matter if there are physical injuries or physical sickness.
Emotional Distress and Mental Anguish
Compensation which is received for mental anguish or emotional distress directly connected to physical sickness or physical injury can be non-taxable.
If there is no relation between the mental anguish or emotional distress and a physical injury then the settlement is taxable.
So take for example that Jason was not injured by a chainsaw, but rather Jason’s ex-girlfriend tells people in town that Jason steals money from the local church.
It ends up that these statements are untrue and Jason’s landscaping business gets destroyed because of the damage to his reputation among the community.
Jason files a defamation lawsuit against his ex-girlfriend and they settle out of court for $20k.
In this situation the whole $20,000 is probably taxable because Jason only suffered emotional and monetary damage.
There are other taxable personal injury settlements with non-physical injuries like:
Invasion of privacy
Car Insurance Settlement For Lost Wages is Taxable
When you are compensated for lost wages it is supposed to replace what you would have earned in wages if you hadn’t been injured.
In the instance you don’t make a complete recovery, there is a chance you’ll also receive compensation for future lost wages.
People ask “why do I have to pay taxes on an insurance settlement for lost wages?”
The answer is because wages are taxable, so any compensation for lost wages is then taxable.
Paying taxes for lost wages can be a very tricky situation.
Sometimes you are taxed on several years of income in the actual year that you get a settlement.
This scenario can cause you to be taxed at a higher rate than normal.
Let’s say you normally earn $35,000 per year and you pay a 15% tax rate.
But imagine you receive 3 years worth of lost wages in your settlement, now you are paying taxes on $105,000 which puts you in a much higher tax bracket.
In addition you’ll have to pay Social Security and Medicare taxes on that insurance settlement money that you receive.
As you can see it’s a complicated situation when you have to deal with the IRS and any settlement you get after being injured in a car accident.
Contact Daniel Kim and his legal team today for a FREE consultation.
Get answers to your questions, don’t fight the insurance companies alone.
How To Reduce Your Accident Injury Settlement Tax Obligation
If you were injured in an accident and you received a financial settlement that included compensation for lost wages and pain and suffering, then you will most likely be paying taxes.
There are ways though to help minimize the amount of taxes you might pay.
Structured auto insurance settlement
If you are awarded a large settlement (maybe that covers 5 years of future lost wages) you can avoid some taxes by choosing to have your money paid to you over an extended number of years.
This is what they call a structured settlement and may let you exclude some of the income payout from current taxes.
Classifying damages in your car accident settlement
Basically there are two categories of damages when you sue another driver, which are general damages and special damages.
General damages are usually more subjective and include non taxable pain and suffering.
Obviously the goal is to obtain a tax-friendly (paying less taxes) settlement.
Personal Injury Compensation Payments Taxable?
As we mentioned above, it gets very complicated when it comes to paying taxes on a personal injury settlement that you win.
The best advice we can give you is to call Daniel Kim Law Offices today for answers.
Dealing with the IRS is something we all want to avoid, whether it’s regarding your normal tax filings in April for the previous year, or if it’s to do with a personal injury claim.
Let an experienced personal injury lawyer help you better understand what possible taxes you might owe on the insurance settlement you get.