What you Should Know About Taxes and Personal Injury Lawsuits

If you have a personal injury lawsuit, you may be looking forward to a large financial recovery. Perhaps you are already considering how you will use the funds. Perhaps you need to pay off large medical debts that have plagued you for years. Maybe you require certain expensive medical assistive devices, such as a motorized wheelchair or adapted shower. Maybe you need to have your vehicle adapted for special use, due to your injuries. Whatever your intention, you probably have one big question: is my recovery taxable?

Is a personal injury settlement taxable income?

No, in general any money you recover from personal injuries is considered non-taxable income. Some feel this is wrong. They argue that such a significant unearned, financial windfall ought to be taxable. If you think about it carefully, however, it actually makes good sense not to tax a personal injury recovery. After all, a personal injury lawsuit is designed to compensate a person for some injury incurred due to someone else’s negligence.

The purpose of the lawsuit is to make the victim whole again, meaning it should put them back in the position they would have been in if not diminished somehow by the injury. This means there is a presumption that one has lost income and physical ability and should be made better. For this reason, the money is not extra income on top of their existing income; it is replacement income for what has been lost.

Are there any exceptions to the general rule?

Yes. Not all personal injury funds are tax-free. If your case proceeds to a jury trial and a verdict is rendered, you and your attorney need to carefully consider how the damages are assessed. An award based on physical injuries or special damages (medical costs and expenses) is tax-free. This is because the money is designed to make you whole again. However, there are other types of damages for which a jury can compensate you. These might include punitive or hedonic damages. These awards are designed to punish the defendant and prevent future negligence or to compensate you for intangible losses, such as emotional pain. These types of awards are taxable income.

Are my attorney’s fees deductible?

Yes and no. It really depends on the type of recovery you receive. Most lawsuits are settled. In fact, according to a 2004 study, roughly 97 percent of all civil lawsuits settle out of court rather than going to trial. Therefore, you may have the option of deciding how your damages are apportioned. If you are in a state that allows such selective apportionment, you should ask your lawyer to list the settlement as compensatory damages, thereby making the award tax-free.

In general, personal injury lawyers charge a contingent fee, meaning they collect a percentage of your award. The award is the total amount you recover before the attorney’s fees, so any fees paid come out of your award. Therefore, if the award is tax-free, so are the attorney’s fees. Hence the importance of working with an experienced attorney who understands these complex issues.

If you are injured in or around the Bradenton area, call the Romero Law Firm for a free consultation today. We are happy to advocate for your rights during this difficult time.