Are personal injury settlements considered income?

Is a Personal Injury Settlement Taxable Income?

Most personal injury cases end with a settlement. If this is what happened with your case, you wonder if the money you received from your settlement is considered income for tax purposes, especially if you received a lump sum payment – which is what typically happens with personal injury settlements. In general, settlement funds can be taxable, non-taxable, or partially taxable. Therefore, the answer ultimately depends on the circumstances involved.

Settlements Related to Physical Injuries and Illness Are Often Tax-Free

Compensation in the form of a settlement for illness or physical injuries is usually not considered income for tax purposes. If, for example, you received $50,000 from a local business to cover medical expenses related to a slip-and-fall accident, that settlement would likely not be considered taxable income. However, if it took a while to reach the settlement and you deducted that same $50,000 for medical expenses on your prior tax return, it would then become taxable since you already benefited from a tax break related to your medical expenses.

Settlements for Mental/Emotional Distress Could Be Tax-Exempt

Under certain circumstances, a settlement that includes compensation for mental or emotional anguish or distress may not be considered taxable income. For instance, if your physical injuries caused you mental distress, the settlement you received would likely be considered medical in nature and non-taxable.

But if the award for mental or emotional distress is not related to a physical injury or illness, it would typically be considered taxable income. For example, if you sued a neighbor for defamation because they spread false rumors about you and those rumors ultimately contributed to the collapse of your local business, the resulting settlement would likely be considered income. Settlement compensation also tends to be taxable if the settlement is related to:

• Wrongful termination
• Some type of discrimination
• Harassment

Settlements Related to Punitive Damages Are Generally Taxable

Settlements may go beyond medical expenses and include a monetary payment intended to “punish” the responsible party/parties. Compensation for this purpose is referred to as punitive damages. Normally, punitive damages are considered taxable, but there may be certain exceptions.

What About Lost Wages and Legal Fees?

If some of your settlement is for lost wages or loss of income, this portion of your settlement would likely have to be declared for tax purposes on your tax form. As for deducting your legal fees, you’ll likely be able to do this only if attorney’s fees are related to a settlement for medical or health-related issues.

Why Contact a Lawyer When Seeking a Settlement?

Because there are many exceptions to just about any type of settlement and the related tax rules, it can help to work with an attorney in Illinois specializing in personal injuries. If there are tax concerns related to your settlement, a lawyer may direct you towards an accountant or financial advisor. Contacting an attorney also gives you access to the legal guidance and assistance required to negotiate a fair settlement.