Of course, the most desired outcome from a personal injury or auto accident case is receiving compensation that will help you recover from your injuries and return to as normal of a life as possible.
While that’s the end goal, it’s important to understand how any money you might receive could impact your individual income tax situation for the tax year in which you receive the settlement check.
In most cases, the income you receive from a settlement for personal injury is not taxable by federal or state agencies. According to the IRS, “if you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income.”
However, the same document notes, “If you receive a settlement for personal physical injuries or physical sickness, you must include in income that portion of the settlement that is for medical expenses you deducted in any prior year(s) to the extent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro-rata basis the part of the proceeds for medical expenses to each of the years you paid medical expenses.” Proceeds for emotional or mental anguish are treated in the same way.
Exceptions to Consider
The most important exception is in the instance of punitive damages, or monies issued on top of the original settlement amount in response to something intentional or negligent by the guilty party. This income is taxable and is typically separated in the verdict as proof to the IRS of the separation of damages.
Many states have passed laws capping punitive damages, but Arizona is not one of them. Instead, Arizona case law has precedent in place to limit excessive or arbitrary punitive damage awards in most cases.
Lastly, any interest paid on a judgment is considered taxable. If a case has been pending for a while, many courts will add interest in respect to the amount of time it has taken for the case to resolve.
If the award is for emotional injury only, with no physical injury, then the settlement award is taxable. The winning party would have to prove some sort of physical injury in order to avoid taxation on the settlement award.
What About Lost Business Profits?
If you’re self-employed and an accident causes you to lose time or the ability to create income, “the portion of the proceeds attributable to the carrying on of your trade or business is net earnings subject to self-employment tax,” according to the IRS.
A Note About Punitive Damages
Again, according to the IRS, “punitive damages are taxable and should be reported as ‘Other Income’ on line 21 of Form 1040, Schedule 1, even if the punitive damages were received in a settlement for personal physical injuries or physical sickness”.
If you’re beginning the process of a personal injury case, it’s important to look at the broader picture and understand any tax liability you could incur. In some situations, a quicker resolution may mean less tax burden overall while a longer proceeding could mean something else entirely.
This is why seeking the guidance of a qualified Arizona personal injury attorney is so important. Call the team at Rabb & Rabb, PLLC today at (520) 888-6740 to learn more and schedule your free consultation.