Are Compensatory Damages from a Personal Injury Claim Taxable?

Serious injuries in an accident can wreak havoc on your finances. Suddenly, you may find yourself with a stack of medical bills to contend with. Many severe injuries can prevent you from working, which means that you may not have a source of income.

Very quickly, you can end up with a financial mess—and digging yourself out may take considerable time, especially as you determine whether you can eventually go back to work in your previous capacity, what your future work needs will look like, and how you will manage your medical bills.

Then, you may receive the proceeds from your personal injury claim. Those funds offer a great deal of convenience and assistance when it comes to paying your bills and compensating for some of that lost income, but you may need to figure out how to manage those funds appropriately so that you can make the best possible decisions about them.

Do you have to pay taxes on those funds?

A Look at Compensatory Damages

To determine whether you should expect to pay taxes on compensatory damages after a personal injury claim, first, start with a look at the different types of damages you may pursue.

Compensatory damages offer direct compensation for economic losses related to your injuries. According to the IRS, compensatory damages awarded for visible, physical injuries do not get taxed. This includes damages related to:

Direct Medical Expenses Due to Your Injuries

A serious accident can leave you with immense medical expenses, especially if you suffered injuries that will have long-term repercussions and the need for ongoing treatment. In fact, those medical bills will often form the foundation of a personal injury claim. You may recover compensation for everything from emergency treatment to ongoing physical and occupational therapy that will help you learn how to cope with the limitations created by your injuries.

In addition, you can claim compensation for psychological treatment resulting from a direct physical injury. For example, many accident victims suffer from PTSD. Others may suffer from immense emotional distress related to their injuries, especially as those injuries cause substantial limitations on their lives or prevent them from interacting with friends or family members the way they did before the accident. According to IRS regulations, funds intended to help with the treatment of those emotional challenges stemming from physical injuries will not require the victim to pay taxes.

Compensatory funds intended for medical expenses help replace the money spent on those treatments. They do not serve as a source of income for the victim of the accident, but rather offer much-needed funds to help pay for expensive medical bills that occurred due to the negligence of another party.

Your previous years’ taxes can affect taxes on compensation related to medical expenses. While you do not have to pay taxes on the compensation you receive directly for your medical bills, some factors can change your need to pay taxes on that amount.

Often, your personal injury settlement will arrive well after you suffered serious injuries in an accident. You may have consulted with an accountant the previous year and decided to claim a deduction related to your medical expenses on your taxes for that year to help alleviate your immediate financial burden. If you did receive tax credits as a result of those medical bills, you may need to claim some of the compensation for medical bills on your taxes the year you receive the award to offset the tax credits you received in previous years. Always consult with an accountant before filling out your taxes if you have odd or difficult circumstances related to your claim.

Lost Wages Because of Your Injuries

Losing your income as a result of severe injuries can feel devastating. You have immense medical expenses to contend with, your regular bills do not stop coming in, and yet you may not have any source of income to help you manage those expenses. Some employees, especially those who work on a salaried basis, may have some temporary disability income or take sick days to cover some of the cost of those lost wages. Others, however, may have little recourse.

Compensatory damages can help cover the financial loss of those missing wages, and you do not have to pay taxes on those funds. Although compensatory damages for lost wages replace your income during that period, you will not have to pay employment taxes on that income, in part because the final award for a personal injury claim usually does not break down the specific categories to which each type of damage belongs. Instead, you will typically receive a single check that covers all the damages related to your personal injury claim.

Direct Financial Losses Related to the Accident

Sometimes, your accident may result in immense financial losses. For example, if you suffer injuries in a car accident, you may have serious damage to your vehicle that can cost thousands of dollars to repair. In some cases, the insurance company may even choose to total the vehicle, deeming that it will cost more to repair the vehicle than it will cost for you to simply replace it. You may then receive funds from the liable party’s insurance company to repair or replace your vehicle.

Like the damages awarded for your injuries, those funds help to replace the thing lost in the accident, and you do not have to pay taxes on those funds.

Do You Have to Pay Taxes on Damages for Pain and Suffering?

As part of your personal injury claim, you may receive compensation for the pain and suffering that you faced as a result of the accident. Depending on who caused your accident, the insurance company that covered that party, and the extent of the damages you suffered in your accident, compensation for pain and suffering may make up a considerable percentage of your claim.

In most cases, however, the claim will not directly break down exactly how much compensation you receive for each element. The insurance company will not write a separate check for your medical expenses and the compensation for your pain and suffering. Furthermore, in many cases, you may use that compensation to help rebuild your life after the accident, from purchasing durable medical equipment or modifying your home to make your recovery easier and mobility more practical to pursuing a new line of work to get back to work after the accident.

Most of the time, you should not have to pay taxes on compensation for pain and suffering related to a serious accident.

Other Types of Damages: Do You Have to Pay Taxes?

While you do not have to pay taxes on compensatory damages from a personal injury claim, you would need to pay taxes on punitive damages. Punitive damages serve as a punishment for the party that committed the act of negligence. Often, the court will assign punitive damages to a drunk driver, especially one with a long history of driving while intoxicated. These punitive damages serve as a deterrent to help prevent the negligent party from engaging in those behaviors again in the future.

Punitive damages also get paid directly by the liable party, rather than by that party’s insurance company.

If you receive punitive damages after your accident, you may have to pay taxes on that amount.

How to Manage Your Finances and Taxes After a Serious Injury

You suffered serious injuries in an accident. You know that you have the right to file a personal injury claim, and you plan to move forward with that claim as soon as possible. In the meantime, however, you have to contend with substantial medical bills and other expenses related to your injuries, not to mention the loss of income you may face.

1. Talk to a Lawyer as Soon After Your Accident as Possible.

Before you start making major decisions regarding your finances after an accident, talk to an experienced personal injury lawyer. A lawyer can give you vital advice regarding your finances after a serious accident, from how much compensation you should pursue in your personal injury claim to how long it may take you to claim that compensation. It may take several months before you arrive at a resolution to your claim. In the meantime, an attorney can provide vital advice about your legal responsibilities when it comes to managing your expenses, from your medical bills to your current bills.

If you have medical bills coming due, but have not yet received the funds from your personal injury claim, your attorney can also issue a letter of protection. A letter of protection establishes your intent to pay your medical bills once you receive funds from a settlement or court award. By issuing a letter of protection, you can alleviate some of the immediate financial pressure associated with those bills and prevent them from going to collections when you cannot afford those funds. A letter of protection can also make it easier for you to move forward with the medical care you need despite those injuries.

2. Get in Touch with a Tax Preparation Professional or Accountant to Ask Vital Questions About Your Financial Needs.

Dealing with your finances in the aftermath of a serious personal injury can be tricky. As the time draws near to file your taxes, you may wonder if you should claim your medical expenses or wait until you have received compensation for your injuries so that you do not have to pay taxes on that amount. What should you do about your bills? How should you manage those costs?

An accountant can help answer many of those vital questions and help you make decisions about how to handle those bills moving forward.

You should also work with a tax preparation professional and/or an accountant to ensure that you take care of all necessary details when it comes to reporting settlement funds and getting the help you need in your personal injury claim. If you received a large settlement, an accountant can advise you about how to best use those funds—which bills you should pay off first, how to manage future expenses, and what you may need to do most to manage your bills in the future.

3. Keep Track of All Expenses Related to Your Accident and Your Injuries.

Accidents can quickly grow expensive, disrupting your finances and leaving you struggling to decide what to do next. You may have medical bills pouring in; not just bills from the medical professionals who provide your care, but bills related to transportation, durable medical treatment, and stays away from home, especially if you need to receive special treatment from a specialist provider.

You can claim and receive compensation for many of those expenses through your personal injury claim. However, if you do not keep track of them, it may become more difficult to receive full compensation for all your financial losses. Track your medical bills and personal bills related to the accident so that you can give them to your attorney, who can then use them to put together a comprehensive personal injury claim that will include all of your injuries. You may also want to track work-related losses, from specific lost hours at work to lost vacation time or sick time or projects you had to turn down as a result of your injuries.

Dealing with the aftermath of severe injuries can leave you with questions about your legal rights, your finances, and your treatment plan. Having the right team of professionals on your side can make a big difference in your eventual financial recovery. Start by contacting a personal injury lawyer as soon after your accident as possible so you can get a better idea of the compensation you deserve and how it may ultimately affect your finances.