Don't Spend Your Personal Injury Settlement Right Away, You May Need To Pay Taxes On It

Before you start spending your personal injury settlement or court award, make sure that you set some money aside for taxes. Depending on the type of settlement or award that you were granted, you may have to pay the IRS.

Physical Injury

If the settlement or court award for your personal injury suit was meant to compensate you for a physical injury or illness, you are not required to pay taxes on that portion of the award.

If, for example, you suffer from severe back pain and receive a physical injury award to compensate you for your back pain as well as past and future medical bills, the IRS will not tax this type of award. The IRS will not tax it because the money you were awarded is an attempt to compensate you for your injury. The award is not trying to make up for lost income.

Mental Anguish Or Emotional Distress

If the settlement you receive is compensation for mental anguish or emotional distress, you will have to pay taxes on the settlement. The IRS will consider your award "other income", and you will need to report your settlement on the IRS's 1040 form.

However, you may get a little tax relief if you had to pay any bills related to psychological or medical are for your mental anguish or emotional distress. You can directly subtract any medical bills that you paid with your settlement from the total amount of "other income" that you report on your 1040 form.

Compensation For Lost Wages and Punitive Damages

Any portion of your settlement that is an attempt to compensate you for lost wages or is an award for punitive damages is taxable. You must report this as ordinary income and pay taxes just like you would on all other employment income.

Attorney Fees

You can actually deduct any attorney fees that you paid in pursuit of your settlement on any taxable portion of your settlement. You can deduct your attorney fees because the IRS in general allows you to deduct expenses that help you earn your income. This is considered a miscellaneous expense by the IRS, which means that the amount you paid your attorney must exceed 2% of your adjusted gross income in order for you to claim the deduction.

Before you start spending the settlement you were awarded from your personal injury lawsuit, make sure you understand your tax obligations. If you were awarded compensation for physical injuries as well as other categories such as lost wages, punitive damages, mental anguish or emotional distress, part of your settlement will be non-taxable and part will be taxed. If you have any questions related to taxes and your settlement, consult with an attorney from firm like Bangel, Bangel, & Bangel, or with a tax expert.