If you have suffered a personal injury, you may have collected damages through a personal injury settlement. A settlement award can offer much needed relief and may even have significant impacts on your financial position. It is important to know, however, that a settlement may affect your taxes. Whether you will have to pay taxes on a settlement generally depends on the size and components of a settlement. There are federal guidelines that dictate what part of a personal injury settlement is taxable.

Compensatory Damages

Compensatory damages are intended to cover financial costs incurred by a victim. These may include medical expenses, loss of wages, pain and suffering, emotional distress and legal costs. Most compensatory damages in a personal injury settlement are not taxable. There are, however, a few exceptions to this. Some cases where compensatory damages can be taxable include:

  •         If you received a tax deduction on any amounts related to the settlement, then those amounts are taxable.
  •         Any amounts of the settlement paid towards interest may also be taxable.
  •         Award amounts for property damage that exceed that cost of the property damage can be taxable.
  •         In some cases, compensation for lost wages can be taxed since it is meant to replace your normal taxable income

Compensatory damages are only non-taxable for physical injuries. If you received a personal injury settlement only for something like discrimination or emotional distress, but no physical injury was inflicted, then the award amount is taxable.

Punitive Damages

Punitive damages exceed the regular compensatory damages and are used as punishment to the responsible party. Punitive damages can be recovered when the injury was caused by malicious or intentional actions. All punitive damages recovered in a settlement are considered taxable income. How much you will owe in taxes simple depends on the award amount you received for punitive damages and any taxable compensatory damages.

Estate Taxes

It is important to remember that once you receive a personal injury settlement it may affect your estate plan and estate taxes. The federal estate tax exemption is about $5.45 million, so if your personal injury settlement exceeds this amount, you will need to revise your initial estate plan to factor in the increased amount. Depending on what state you live in, you may also have to include state estate taxes. It is important to accurately adjust your estate plan and the appropriate paperwork to reflect the increased value of the estate. Misrepresenting the facts can result in fines or penalties, even if by accident. A tax and estate planning lawyer Roseville CA counts on can help you ensure this doesn’t happen.

Some of the federal tax guidelines for personal injury settlements and estate plans can be difficult to determine, especially if your situation is more complex. It can be helpful to speak with a personal injury lawyer to determine how your settlement may be taxable. In addition, whether or not you already have an estate plan in place, a settlement is likely to have a substantial impact on you current financial standing. An attorney can help you to determine how your estate and estate taxes may be affected, and they can also help you create an estate plan if you don’t already have one.

Thanks to our friends and contributors from Yee Law Group for their insight into personal injury and estate planning.