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How Are Personal Injury Settlements Taxed?

Written by Ankin Law Office

Many personal injury cases are resolved via negotiated settlement agreements instead of being litigated in court. The main idea behind the tort system is that victims are made whole for the losses they suffered due to their injuries. Depending on the injuries or losses a victim is being compensated for, a personal injury settlement may be taxable.

What Part of a Settlement Is Taxable?

Under Federal Law, personal injury settlements are generally not subject to taxes. However, if a victim’s settlement is based on a lost wage claim, it is taxable. This is because lost wages are not considered compensation. Lost wages are classified as money the victim would have earned, and paid taxes on, had they not suffered an injury. If a portion of a settlement is based on punitive damages, it is taxable as punitive damages are not designed to compensate an injured victim. Punitive damages are meant to punish a person if his or her conduct was reckless, wanton, or willful. If a victim suffered an illness or physical illness from a breach of contract, the settlement is subject to being taxed. Finally, if a victim obtains a financial settlement that is not taxable but deposits the money into an interest-bearing account, the interest is taxable as it is classified as additional income.

What Portion of a Settlement Is Not Taxable?

If a victim’s settlement stems from a physical injury or illness, it is not taxable. If a victim suffered emotional distress due to a physical injury, the resulting settlement cannot be taxed. Settlements that victims receive for non-economic damages such as physical disfigurement, or pain and suffering, are also not taxable. A settlement is also not taxable if a victim receives money for economic damages such as medical expenses, or property damage. 

What Types of Personal Injury Settlements Are Not Taxable?

Very often, personal injury lawyers in Chicago, Illinois negotiate settlements that are paid to victims as a lump sum of money. Victims who obtain large settlements sometimes choose a structured settlement agreement, i.e., one that is paid out over time as opposed to a lump sum of money. Structured settlements provide many benefits. They provide tortfeasors, and insurance companies, with financial predictability. The main benefit for victims is structured settlements are not taxable and therefore maximize their financial recovery.

Categories: Personal Injury