After being involved in an accident, you may file a Gulfport personal injury claim to receive compensation for the damages you’ve experienced. However, it’s common to wonder whether the compensation received is subject to taxation, as this can make a significant difference in the amount that goes into your pocket. 

Personal Injury Settlements Are Generally Tax-Free

The Internal Revenue Service (IRS) typically doesn’t require you to include your personal injury settlement in your taxable income, which means that the financial compensation you receive as a result of your injuries is typically tax-free. This is particularly true if the settlement is meant to cover medical expenses, pain and suffering, and emotional distress resulting from a physical injury or illness.

Reimbursement for Anguish and Distress 

If your personal injury settlement is intended to cover the costs incurred to treat the emotional anguish and distress you experienced as a result of the related incident, the IRS usually considers this portion of the settlement to be tax-free. 

However, it’s important to note that if you receive a settlement for emotional distress without any physical injury or illness involved in the incident, you will generally be required to pay taxes.

Settlements for Lost Wages and Damaged Property

In cases where a personal injury or illness caused the victim to lose wages, the settlement amount intended to compensate for lost income is usually not taxable. Similarly, if you receive a settlement to cover the cost of repairing or replacing your damaged property – such as a vehicle damaged in a car accident – that portion of the settlement is also generally tax-free.

However, if the amount you receive for damaged property exceeds the property’s value, the difference is considered taxable income. For example, if your car was worth $10,000 but you received a $15,000 settlement for its damage, the extra $5,000 would be considered taxable income.

Punitive Damages Are Taxable

Unlike compensatory damages – which are meant to reimburse you for your losses – punitive damages are awarded to plaintiffs when the defendant’s behavior is deemed especially egregious. Because they’re meant to punish the culpable party rather than reimburse the victim, the IRS requires you to pay taxes on any punitive damages you receive.

It’s crucial to keep records of all settlement payments you receive, detailing which portions were for compensatory damages and which were for punitive damages, as this information will be essential when filing your taxes.

How To Minimize Tax Liabilities

Here are two important tips on how personal injury victims can minimize their tax liabilities:

Keep thorough documentation of all expenses

Maintain a complete and accurate record of all medical and non-medical costs related to the injury. This documentation will serve as substantiation for any tax exemptions should the IRS inquire about your settlement(s) claimed. 

Always Consult a Tax Professional

Tax laws and regulations vary by state and can change frequently. To ensure the best possible outcome in terms of taxation, it’s wise to consult a tax professional who specializes in personal injury settlements and has a thorough knowledge of the relevant tax laws in your jurisdiction.

The taxability of personal injury settlements largely depends on the type of compensation being awarded and the specific circumstances of the case. If you have questions or need help, contact us today to schedule a free consultation.