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Are You Obligated to Pay Taxes on Personal Injury Settlements?

The taxation of settlements received as part of court litigation may or may not be taxable depending on what the settled amount is in compensation for.

According to IRS regulations, personal injury benefits, those received in compensation for physical injury or physical sickness, are not included in income. This does not however mean however that all sums awarded in personal injury litigation are free from taxation.

In most cases punitive damages awarded as part of a personal injury settlement will be subject to taxation at ordinary income levels. Punitive damages from awarded in a personal injury settlement will be taxed as ordinary income even if they relate to the underlying claim for physical injury or physical sickness.

Any portion of a personal injury award or settlement that is attributable to lost wages will be subject to income tax as well. The justification for taxation of this portion of the award is that the recipient would have been liable for taxes on those wages if they had been earned outside of court.

In some cases certain deductions can be made from the taxable portion of personal injury awards or settlements for items such as court costs and reasonable attorney's fees.

There are many types of court awards other than personal injury settlements that may or may not be subject to income tax. Not all injury settlements are taxed as regular income. In many instances court awards may be taxed at the lower capital gains rates.

A general rule of thumb for taxation of court awards or settlements is that they are taxable if they would have been taxed if earned outside of court.

For a complete list of the tax treatment of court awards and damage settlements, see the 2011 version of IRS publication 525.

To learn more about taxes on a personal injury settlement and what obligations you may face, contact Cheadle Law at 949.553.1066. They will look at the specifics around your particular case and settlement and will be able to guide you to the best outcome.

A review of any materials on this web page, any preliminary comments or an introductory meeting does not constitute legal, income tax or accounting advice upon which reliance can be placed. The attorney client relationship can only be created by a written retainer agreement following a check of potential and actual conflicts of interest with other clients.
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