The laws in Virginia governing personal injury can be confusing enough, but even tax experts are sometimes left scratching their heads when asked about the federal and state tax implications of a personal injury settlement and personal injury statute of limitations.
In general, settlement awards are not subject to taxation because the purpose of the compensation is to cover expenses and loss of income due to an injury or illness–and are not income earned. However, there are exceptions that your personal injury attorney in Virginia Beach can explain as it relates to your case.
You can receive compensation for a physical injury, non-physical injury, and punitive damages resulting from someone’s wrongful actions. Determining if these damages are subject to taxation or exempt depends on the nature of the injury.
Tax-Exempt Portions of a Personal Injury Settlement
Damages that are not taxable by the Internal Revenue Service (IRS) or the Commonwealth of Virginia include:
- Settlements that cover lost income, medical expenses, emotional distress, pain and suffering, loss of consortium, and legal fees are exempt as long as they stem from a physical injury.
- Awards received for emotional distress and mental anguish resulting from physical injury are exempt if they were not previously claimed as an itemized deduction in previous tax years.
- Wrongful death settlements are treated the same way as personal injury settlements and are not taxed (punitive damages awarded in wrongful death claims are also tax-exempt).
Portions of a Settlement That Can Be Taxed
Not all components of personal injury settlements are exempt from taxation. For example, punitive damages, which are intended to punish the defendant for negligence or wrongdoing, are generally considered taxable income. However, punitive damages are relatively rare in personal injury cases.
If you receive proceeds for emotional distress or mental anguish that are not a result of a physical injury, you must include these amounts in your taxable income. The taxable amount is adjusted by what you paid for medical expenses related to emotional distress or mental anguish that were not previously deducted, as well as previously deducted medical costs for distress and anguish that did not provide a tax benefit.
In some instances, the IRS may tax interest or dividends earned on a personal injury settlement. Large lump-sum settlement amounts can generate significant income in the form of interest, so it’s advisable to consult with a tax professional to manage potential tax consequences.
If you claimed deductions for accident-related medical expenses on your taxes in prior years, you may be required to pay taxes on those deducted amounts if you receive a settlement that reimburses you. This can occur in lawsuits that take place months or years after the initial medical treatment.
It’s also possible that these tax situations will only apply to a portion of your settlement. For example, if you deducted emergency room costs in the previous year but have not yet deducted surgery costs from the current year, only the emergency room reimbursement is eligible to be taxed.
Certain personal injury cases may qualify for punitive damages. If you were awarded them, they are subject to taxation under IRS guidelines. However, this does not mean that the rest of your settlement will be taxed.
Talk to a Pro
If you are concerned about the tax implications of a settlement that you received or are expecting, talk to a professional at Coastal Virginia Law for advice and personal injury settlement amounts examples. We will steer you in the right direction to ensure that you don’t find yourself in a sticky situation when it comes to your federal and state taxes.