A personal injury claim can sometimes take years to complete, even if there is a settlement agreed to very early on in the process. The wait can be made longer if the case has to go to court, and then your attorney has to constantly petition the court to get the other party to pay. After all of that anguish to get money to help pay for the expenses you accrued due to an accident that was not your fault, you figure the settlement money has to be tax free, right? The reality is that some parts of your settlement are tax free, while others carry the income tax stigma.
By the time you finally get your settlement, your medical bills have already been handled in one way or another. Either your insurance company paid them, you paid them out of your pocket, or you went bankrupt. Your settlement is carefully calculated to compensate you for any medical expenses you paid out of your pocket.
If you did not itemize your federal income tax filing for that year to deduct the costs of your medical bills, then the medical portion of your settlement is not taxed. If you used your medical bills as a deduction, then the settlement money designated to pay medical bills is taxed.
It makes sense that any money in your settlement designated to be used to pay for lost wages or income is taxed at regular income tax rates, but it still comes as a surprise to people. Your settlement will have an itemized list with it to describe where every dollar comes from. The part that is used to cover lost income is taxable.
It is hard to imagine any civil court awarding compensation for mental anguish that is not directly related to injuries sustained in an accident, but it does happen on occasion. If the amount you are awarded for mental anguish is directly related to your injuries, then it is not taxed. If the courts awarded you mental anguish not associated with your accident, then that money is taxed.
In civil cases where the court feels that the defendant needs to be taught a lesson above and beyond the standard award, the court will add punitive damages. These types of damages are often awarded as a way to make an example of the defendant or possibly remove the financial means the defendant has to perpetrate their heinous acts. While the reasoning behind awarding punitive damages is relatively noble, these types of damages are taxed as income.
Not only do you need an attorney to file a personal injury claim, you also need an accountant. There is a strong chance that the settlement money you receive or the award you are given by a court could be taxable. Instead of taking chances, it is always smart to have your accountant look your final settlement over and make sure you pay all of the taxes you need to pay before you start spending your money.