The claims you receive are either an out-of-pocket expense or an extra income. Legal procedures take a lot out of you financially and mentally. The court cannot fill up your physical and mental loss. However, money is the best way they can help you. The court tries to cover property loss, anxiety, loss of income, physical pain, punitive damage, etc.
The important question that arises is that do you pay taxes on settlements? This is because out of these claims, some are taxable, and some are not. It depends on if they are an income or an expense. For instance, personal injury settlements are usually an expense on all the hospital bills. Hence, they are tax-exempt. You may hire a tax attorney to understand these things better.
Taxable Settlements
The post-settlement procedure is about taxing your settlements. The claims that are a direct or indirect income for you are taxable. The court provides money to cover loss of income due to the accident or any other incident. It is fair to tax this damage as it is your income.
Punitive damages are compensation you get from the defendant. It is a punishment, to the defendant, for harming you in neglect. This revenue is also an extra income for you. Hence, it is taxable.
Other such settlements, including Social Security Disability Income (SSDI), are taxable.
Non-Taxable Settlements
As already discussed above, out-of-pocket expenses are tax-exempt. Non-taxable claims include personal injury, accident claims, loss of income, etc. Claims that you can receive for physical loss are:
- Hospital bills
- Medicines
- Assistive devices like a wheelchair
- Doctor’s visits
- Over-the-counter pharmaceuticals
Your compensation amount will depend on how critical the injury is. Chronic damages are likely to claim a high amount and vice versa. The claims that you receive for property loss are also tax-exempt. Motor-vehicle accidents, car accidents, loss from fire, and other such incidents come under this claim.
Wrongful Death Claims
Personal injury claims that family members file for a wrongful act, neglect, or defect for taking a life are wrongful death claims. The court compensates families for the loss of future income, funeral expenses, and the absence of future inheritance. However, no amount of compensation can recover the death of a family member.
These claims are not taxable. You don’t need to show them in your income.
The Bottom Line
The Internal Revenue Service (IRS) divides the claims into two main categories; compensatory and punitive damages. Compensatory damages are compensation for any expense or loss arising from the incident. These include any injury, property loss, etc. These are not taxable.
On the other hand, punitive damages are income arising from the defendant. They are not an expense. Hence, they are taxable. The IRS rule imposes a tax of 24 percent on such earnings. Deduct the compensatory damages from your gross income before taxing them.
You may also sign an agreement with the defendant during the trials to avoid these taxes. The IRS usually does not interfere in the tax agreement between the two parties. You can take help from a qualified attorney while doing this official work.
