Personal Injury Settlements: Taxable or Not?

Tax season comes and goes every year. As civil litigation firm in Northern California, Maire & Deedon handles personal injury a lot. We often get a particular question during this time of the year: “Are my personal injury settlements taxable or not?” Well, IRC (Internal Revenue Code) Section 104 (a)(2) specifies that “Amounts received in compensation for bodily injuries or physical illnesses are exempt from taxable income.”

As such, the quick answer is no. Although, as in other areas of the law, there are exceptions. We’ve listed these few exceptions as well as a few other important things to note below.

A. Compensatory Settlements and Punitive Settlements

Compensatory settlements are payments that a defendant makes to a plaintiff in order to compensate them for losses suffered as a result of the defendant’s actions. These payments may be in the form of money, but they may also include other forms of compensation, such as medical care or property damage repair. Compensatory settlements are typically reached through negotiation between the parties involved, and they are designed to provide some measure of relief to the plaintiff without requiring a full trial. The settlement is not taxable.

A punitive settlement is a type of legal settlement that is designed to punish the defendant for their actions. This type of settlement can involve a variety of different penalties, such as fines, restitution, or imprisonment. The settlement is taxable.

B. Interest in Compensatory Settlements

When a plaintiff receives a compensatory settlement from a defendant, the plaintiff may continue to receive interest on that amount while the case is in appeal. This interest compensates the plaintiff for the delay in receipt of the full amount of the settlement.

For example, assume you win an injury or illness lawsuit and receive a $250,000 reward. If you file an appeal, you may collect $3,000 in interest on that initial settlement when the case is resolved. While the original $250,000 isn’t taxed, the $3,000 in interest that accrues on that money is.

C: Emotional Distress Settlements

Emotional distress settlements in personal injury matters are not taxable in the United States. This is because they are considered to be personal injury awards, which are not taxable. This is because they are considered to be a reimbursement for actual damages, such as pain and suffering, that have occurred as a result of the emotional distress.

D. Replacement Insurance Policy or Disability Insurance Policy Settlements

The answer to this question is not a straightforward one, as there are a few factors that need to be considered. Generally speaking, income that is derived from an income replacement insurance policy or a disability insurance policy is not taxable. But, according to the IRS insurance rules, this is true if you paid for the policy. If the insurance policy was/is being paid for by your employer, then the payments you receive will be subject to income taxes.

However, another exception exists. If the premiums for the plan were paid by both you and your employer, only the portion of your disability benefits that you get as a result of your employer’s payments must be reported as taxable income.

Maire & Deedon

We are not tax attorneys, so why did we write this? Well, we have a long history of winning personal injury cases, and we’ve been asked this question about tax and settlements all too often.

So, would you know who to call if you were injured in an accident? How about if you needed to file a lawsuit?

Reach out to speak with a Northern California personal injury attorney at Maire & Deedon by calling (530) 246-6050. We offer the highest quality personal injury and civil litigation services in California. We’re here to help you. We work with a number of insurance firms and would be able to tell you early on if you have a case or not. Contact us today for a free consultation.