If you have recently prevailed in a personal injury case, you may be wondering whether your settlement or judgment is taxable. Generally, an injured person who is awarded compensation due to another person’s negligence does not have to pay taxes on that award. However, there are exceptions to this rule. If you have received a personal injury award and are concerned about your tax liability, you should speak with an experienced injury lawyer. Fayetteville personal injury lawyer Ken Kieklak can help you determine whether you must pay taxes on your injury award. Ken is here to explain what types of injury awards are susceptible to state or federal taxes.
Types of Injury Damages in Arkansas
A person who files a personal injury case may receive compensation in two different ways. First, the injured party (plaintiff) and the at-fault party (defendant) can agree to settle the case out of court. The second option is prevailing in the case and receiving an award from a jury.
There are two types of damages that an injured party can receive after winning an injury lawsuit in Arkansas: compensatory damages and punitive damages. Compensatory damages are funds awarded to a party to compensate for an injury or loss. An example of an award for compensatory damages is money given to a plaintiff injured in a car accident to cover their medical bills. The purpose of punitive damages is to punish a defendant who committed a particularly heinous act. An example of a heinous act can be a person accused of committing repeat and vicious nursing home abuse.
Taxable and Non-Taxable Injury Settlements
There are a few types of injury settlements that are exempt from taxation. According to the Internal Revenue Service (IRS), the entirety of a settlement for personal physical injuries or physical sickness is non-taxable if you did not take an itemized deduction for medical expenses related to the injury or sickness in prior years. This means you do not have to include the settlement proceeds in your income.
However, any money from your personal physical injuries or physical sickness must be included in your income if part of the settlement is allocated to medical expenses deducted from your income in previous year(s), up to the extent that they provided you with a tax benefit.
A settlement you receive for emotional distress or mental anguish that derives from a personal physical injury or physical sickness is also tax free. However, there is an exception to this rule: if the emotional distress or mental anguish did not stem from a personal physical injury or physical sickness, the settlement would be taxable.
Certain factors can decrease the amount you must include in your income, such as:
- Any amount of money used for medical expenses related to emotional distress or mental anguish that was not deducted from your income in a previous year
- Medical expenses deducted in a previous year that was related to emotional distress and anguish, but did not provide you with a tax benefit
The net taxable amount from an emotional distress or mental anguish settlement must be reported as “other income” on your tax return.
A settlement for a loss in the value of property does not need to be reported on your income tax return if the settlement was for less than the adjusted basis of your property. However, your basis in the property must be decreased by the amount of the property settlement. Alternatively, if your property settlement surpasses your adjusted basis in the property, the excess must be reported as income.
If you prevail in an employment-related claim, the portion of the settlement allocated to lost wages is taxable. Lost wages can include severance pay, back pay, or front pay. The proceeds of your settlement should be reported as “wages, salaries, tips, etc.” on your income tax return.
If you run a trade or business and receive a settlement for lost profits instead of lost wages, the portion of the settlement used to continue your trade or business is considered net earnings subject to the self-employment tax. A settlement for lost profits must be reported as “business income” on your income tax return.
Additionally, any interest included in any settlement is taxable as “interest income.” Any punitive damages awarded after a trial are taxable and must be reported as “other income.” It does not matter that the punitive damages awarded were for a case involving personal physical injuries or physical sickness.
The type of compensatory damages received in a settlement will usually dictate their tax status. Therefore, it is important to define the reason a settlement negotiation occurs so that the settlement’s tax status is apparent during tax season.
Fayetteville Personal Injury Attorneys Can Help You With Your Personal Injury Case
If you or a family member received an injury settlement and you wish to know if it is taxable, you should consult with an experienced Arkansas personal injury attorney. Ken Kieklak has decades of experience in various aspects of personal injury cases that he is prepared to use to represent you. Our firm of legal professionals handle several types of cases from commercial vehicle accidents to construction accidents. To schedule a free consultation concerning your case, call us at (479) 439-1843, or reach us online.