Make sure you can keep as much of your recovery as possible
Whenever you receive a significant amount of money, it’s natural to be concerned about the tax implications. In particular, if you’re involved in an accident and need to sue for damages, you may be worried about whether you’ll have to pay taxes on your recovery.
The short answer is generally no, but it depends. The law treats compensation in accident cases differently depending on what you’re being compensated for.
In general, the law doesn’t view personal injury compensation as “income”
There’s a misconception that winning a personal injury case is “life’s lottery,” but nothing could be further from the truth. Unlike winnings in the actual lottery, which are taxable income, compensation in a personal injury case is intended to make you financially whole again. Put another way, you’re not getting free money; you’re being reimbursed for expenses you have already incurred or will incur as a result of the accident.
As a rule, most of the compensatory damages you recover in a personal injury case are not taxable income. This includes compensation for:
- Medical bills
- Future medical expenses
- Pain and suffering
- Emotional distress (if tied to a physical injury)
- Loss of consortium
- Loss of quality and enjoyment of life
- Replacement services (such as childcare or yard work)
In short, if you’re being compensated for something you lost, you shouldn’t have to pay taxes on that money.
One important exception is if your accident case includes compensation for lost wages or lost future income. Usually, these types of compensation are subject to income tax, since the income they are replacing would have also been subject to income tax.
Compensation for property damage is likewise generally not taxed
Just like compensation for your injuries, compensation for any property damage you sustained as a result of the accident is generally not taxable.
In a car crash, for instance, this includes repairs to your vehicle and repair or replacement of any property (such as child car seats) that were in the vehicle at the time of the accident. It also includes diminished value claims – even after repair, the resale value of your vehicle is lower after it’s been in an accident, and you should be compensated for the difference in value. Again, such compensation is intended to make you financially whole, not as taxable income.
If you qualify for punitive damages, they are almost always taxable
Punitive damages (called exemplary damages in some jurisdictions) are intended to punish the responsible party for grossly negligent or intentional behavior, and to deter dangerous behavior by others.
In personal injury cases, punitive damages are uncommon, but they can be pursued in some circumstances. We’re sometimes able to get punitive damages from drunk drivers, for example, or manufacturers who cover up known defects in their products.
If your recovery does include punitive damages, they are almost always taxable, since they are not direct reimbursement for losses you’ve sustained.
Your attorney – and your tax professional – can help you navigate the tax situation
While most personal injury attorneys are not tax experts, we are familiar with the ways taxes interact with personal injury settlements and verdicts.
An experienced injury lawyer will take the tax implications into account when negotiating a settlement or pursuing a verdict on your behalf. When possible, we try to pursue tax-exempt dollars instead of taxable dollars because our goal is to maximize the amount of your recovery that ends up in your pocket.
If your case goes to trial and results in an award of both taxable and non-taxable funds (for instance, punitive damages and compensatory damages, or medical bills and lost wages), your attorney should ask the judge to itemize the verdict in order to separate the taxable and non-taxable compensation. That way, you won’t get stuck paying taxes on compensation that should be treated as tax-exempt by law.
Of course, you are welcome and encouraged to discuss your recovery with an accountant or tax lawyer as well as your personal injury lawyer, especially if you have complex questions about the tax implications.
This is just one of the many reasons it’s so important to go into a personal injury claim with an attorney on your side who puts your interests first. If you’ve been hurt in an accident caused by negligence, speak with an experienced personal injury lawyer in your area as soon as possible.
The Law Offices of Gary Martin Hays & Associates, P.C. is a personal injury law firm in Atlanta, GA.
