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Is a Settlement Considered Income?

The answer to the question of whether a settlement is considered income is “it depends.” That answer is understandably confusing and unsatisfying. Whether an award is taxable depends on the origin of a specific award.

Let’s consider an example. Bob is injured in an accident with a commercial truck driver who was operating the tractor-trailer drunk. Bob sues and is awarded economic, non-economic, and punitive damages. His tax exposure on this settlement will be different for the various types of awards he receives.

The Internal Revenue Service (IRS) rules around which parts of a settlement are taxable can get complicated but applies whether the lawsuit settlement was won through negotiation or by a jury.

When an Award Is Taxable

The IRS has determined that lawsuit settlements are taxable in certain circumstances.

The following awards are usually considered income and are taxable:

  • Punitive Damages. These damages are taxable because they don’t compensate for any economic or emotional loss. The attorney fees paid from your judgment (contingency) may also be taxed. If you are awarded $100,000, but your attorney receives $40,000, you may still be liable for the taxes on the full $100,000.
  • Lost Wages. Lost wages are considered taxable because wages are income that would have been taxed if they were received without interruption. These wages are also subject to social security taxes and Medicare taxes.
  • Interest Earned. Interest earned on any monetary award you receive will be taxed.

When an Award Is Non-Taxable

There are times when an award is not taxed.

Examples of non-taxed awards include:

  • Observable Bodily Harm. Tax settlement awards from personal injury lawsuits aren’t taxed as income if these cases demonstrate “observable bodily harm.” If the injuries are visible, the IRS considers settlement money that was awarded because of those injuries, tax-free.
  • Medical Expenses. Medical appointments for emotional distress or physical injury are not taxed if you did not take an itemized deduction for these expenses in prior years. If your settlement reimburses you for medical expenses you incurred in previous years, and you had deducted those expenses on that year’s taxes, you will be required to pay tax on the settlement in the year you receive it.
  • Emotional Distress. These awards are nontaxable if and only if the distress or anguish originated from the physical injury or sickness caused by the accident. Remember, as stated above, that any medical expenses incurred that were previously deducted may be taxable in the award when the settlement is reached.

Types of Personal Injury Awards

Personal injury awards can include economic, non-economic, and punitive damages.

Examples of economic damages are:

Examples of non-economic damages are:

Punitive damages are meant to punish the defendant for wanton or willful misconduct that contributed to the incident. These awards punish egregious behavior to set an example and discourage such conduct from happening again.

Caps on Personal Injury Awards

West Virginia does not limit the amount of settlement you can receive for compensatory damages (economic and noneconomic) unless it is a medical malpractice lawsuit. In those cases, non-economic damages are limited to $250,000 but increase to $500,000 if it involved wrongful death or a permanent injury. Punitive damages are capped at $500,000 for all civil lawsuits and are generally only available in cases where the defendant acted intentionally or recklessly.

Hiring an Attorney

If you are considering a personal injury lawsuit, put experience on your side. At Katz, Kantor, Stonestreet & Buckner, we have 85 years of experience representing the needs of West Virginians. You can count on us to represent your best interests and work toward the best outcome.

We offer free consultations to discuss your case and potential next steps. Call us at (304) 713-2014 or use our online form to schedule an appointment.