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Do I Have to Pay Federal Taxes on My Illinois Personal Injury Settlement?

The start of a new year always brings to mind the topic of taxes. In a few months, more than 150 million Americans will file their individual income-tax returns for the year just ended with the IRS.

When they do, many will face new questions that they have never had to answer before. Those who started a business last year will need to know how businesses are taxed. Those who got married will need to learn the difference between filing jointly and separately. And those who received a personal-injury judgment or settlement will need to understand how that amount impacts their taxes.

The short answer to that last question is that it depends on what the injured person is recovering for.Amounts paid for physical injuries or physical sickness are excluded from income for federal tax purposes, although there are some exceptions to this rule. Punitive damages and damages for non-physical injuries are generally subject to tax. Let’s consider this topic in more detail.

 

 How the IRS Treats Personal Injury Compensation

 

pay taxes on personal injury compensation

At the federal level, tax law is compiled in the Internal Revenue Code (also known as the IRC). In general, the IRC says that all income, from whatever source derived, is subject to the federal income tax. But the IRC also defines some income as excluded, and provides numerous deductions and credits to reduce the amount of income or income tax.

IRC section 104(a)(2) provides an exclusion for “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.”

We’re quoting that section because the precise language used is important. It only excludes damages on account of “physical injuries or physical sickness.” In general, it does not exclude damages for mental anguish, emotional distress, or other non-physical injuries. But the rules here are complicated. If the non-physical injury is the result of a physical injury, then you may be able to exclude the amounts attributable to that non-physical injury.

And notice that punitive damages are also not excluded from income. That means that, in those rare cases when punitive damages are awarded, the plaintiff must pay income taxes to the extent of the punitive-damage award.

There is another important exception to the exclusion provided by 104(a)(2). The first paragraph of section 104 says that the exclusions that follow do not apply to amounts attributable to medical-expense deductions taken in prior years.

So, if you claimed a deduction for medical expenses caused by an injury on a past form 1040, then you’ll have to recognize the amount of compensation attributable to those medical expenses when you are paid under a judgment or settlement relating to that injury. However, the medical-expense deduction is an itemized deduction, and most people don’t itemize, so this won’t affect everyone.

 Contact the Attorneys of Costa Ivone for Help with Your Personal-Injury Claim

Of course, we aren’t accountants or tax attorneys. If you need help with your taxes this year, you should contact a knowledgeable accountant for guidance. But we would hate for anyone to decide not to pursue a personal-injury claim in the mistaken belief that it will negatively impact their taxes.

And that’s where we come in. Costa Ivone is a Chicago personal injury law firm. We help our clients pursue their claims against others who have caused them injury. If you’ve been injured by another person’s wrongdoing, contact us today for a free consultation.  We’ll help you get the compensation you deserve.

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