Are Pain and Suffering Settlements Taxable?

If you were hurt in an accident caused by another party’s negligence, the legal process could often take months or years before a settlement or payout can be reached. When you receive financial reimbursement for all the expenses and costs you sustained since the accident, it’s exciting and comes as a relief to many. However, it’s essential not to rush the negotiation process until you’re confident in not only the amount offered but also the way the settlement is structured.

Before signing any final settlement offers, be sure you understand what portions of the payout are taxable. If you’re not careful, a poorly structured settlement offer can cost thousands of dollars in taxes alone. Be sure to consult with one of our best personal injury lawyers on your case before any offer is accepted and finalized. Consulting with a knowledgeable attorney with extensive experience in personal injury can help you get the most of your settlement and remove any unnecessary tax liability.

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Are Compensatory Damages Taxable?

Financial reimbursement, known as compensatory damages, are intended to relieve a person for direct costs related to an injury. These damages include compensation for losses related to:

  • Physical injuries
  • Emotional distress
  • Pain and suffering
  • Lost wages

Compensatory damages are not taxed by the Internal Revenue Service (IRS), State of California, or State of New York. Both state and federal taxes have the same requirements on taxable and non-taxable compensations.

Physical Injuries or Ailments

Compensation for both physical injuries and ailments are exempt from taxes. When a person experiences pain, suffering, and emotional distress from physical injuries or illness caused by another party’s negligence, that compensation is tax-free.

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woman wearing a neck brace and wincing in pain while reading a letter from her car insurance

Pain and Suffering

Pain and suffering, along with emotional distress directly caused by a physical injury or ailment from an accident, are not taxable in a California or New York settlement for personal injuries.

However, if there were no physical injuries, and the foundation of the lawsuit is related solely to the harm being mental or emotional distress—those damages will likely be taxed both by the state and the IRS.

Lost Wages or Loss of Income

If your settlement includes compensation towards lost wages or permanent loss of income due to the physical injuries that the accident inflicted, this compensation may be taxed as if it were typical income. Since the compensation you receive replaces your lost income, it can be taxed accordingly. The Barnes Firm’s best personal injury lawyers in Los Angeles recommend going over your options with a tax expert if you recovered compensation for either lost wages or loss of income.

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Toy cars demonstrating an accident on a background of 100 dollar bills

Punitive Damages Are Taxable in California & New York

Punitive damages are awarded by a judge or jury as a punishment when the defendant’s actions were especially heinous or showed complete and utter disregard for human life. An example of a case where a judge may award punitive damages would involve a drunk driver. Punitive damages are meant to deter others from doing the same egregious acts.

Punitive damages are not common in all personal injury lawsuits. However, it’s essential to know the tax effects that they have on a settlement or payout. In California & New York, punitive damages can be subject to taxation by both the state and the IRS.

Because punitive damages are taxable and compensatory damages are not, it’s critical to be meticulous in distinguishing each classification of damages that you’re awarded in a personal injury claim. Your settlement must explicitly identify the amounts that are bestowed to either punitive or compensatory damages. If a significant portion of your settlement is awarded for punitive damages, you can expect to have a high tax liability that can drastically alter the final payout.

Call The Barnes Firm for Experienced Legal Advice on Your Personal Injury Settlement

Before accepting any settlement after your accident, always seek trusted legal counsel. It’s in your best interest to ensure that you’re not overlooking critical details that could alter your final payment outcome. A knowledgeable attorney can be of immense value to help you understand the different damages you are being offered and the taxation related to each category. In a poorly structured settlement, you could stand to lose thousands of dollars. The IRS won’t accept the fact that you were unaware should you fail to include the taxable amounts in your yearly tax return.

At The Barnes Firm, our injury attorneys have extensive experience in personal injury law. Our goal to help our clients learn all of their legal options and help achieve the best possible results. Our successful track record of positive results demonstrates our dedication to helping our clients in their recovery.

If you have questions regarding your personal injury settlement and the subsequent tax liability, The Barnes Firm personal injury lawyers are here to help. To speak with an accomplished injury attorney today, schedule a free consultation by completing our contact form.