Will the IRS Tax a Personal Injury Settlement in Louisiana?

As Benjamin Franklin once said, “Nothing is certain except death and taxes.” But the taxes that can or cannot be incurred by the IRS for a personal injury settlement in Louisiana is an uncertain, complicated issue and worth looking into for added financial protection.

No one likes the financial burden of paying taxes – especially after already physically suffering from injuries after an accident. Understanding all of the facets of a personal injury settlement and which ones are subject to income tax could bring some relief.

Here is a closer look into the applicable taxes that could affect the amount of compensation received from a settlement.

What are the Basics on What is and is not Taxed in a Personal Injury Settlement?

Personal injury attorneys, tax accountants, and professional tax preparers in Louisiana know how important it is for their clients to get the most money they deserve for their settlement.

While more specific conditions or exceptions may vary from case to case, some basic facts and guidelines concerning taxes on personal injury settlements include:

• Cases from insurance companies settled out of court are non-taxable.
• Most physical injury settlements are not considered income in Louisiana or on the federal tax level.
• Non-physical injuries, such as emotional distress, could be considered a taxable form of personal injury. If someone is sued for compensation for a non-physical injury, however, that payment may be exempt if it is the direct result of the physical injury.
• Punitive damages that are ordered when a defendant is found guilty are taxable.
• Any deductions taken out for medical expenses related to a personal injury before the case is settled will have to be paid back to the IRS.
• If a case takes a long time to settle and, because of that, interest is gained on the settlement, that interest is taxable; the settlement itself is not.

What is Not Taxable in a Personal Injury Settlement?

According to the United States tax code, Section 104, personal injury lawsuits can be exempt from taxes, while just about everything else is taxable, from lottery winnings to inheritance money to other types of lawsuits, are. Because personal injury settlements do not qualify as income, they will not affect your Louisiana state taxes either.

Basically, any lawsuit that does not result from or include physical harm will be taxed, such as:

• Wrongful termination
• Discrimination
• Defamation
• Intentional infliction of emotional distress

Accident victims who sue for compensation for emotional distress, which is usually taxed, will not need to pay taxes on the settlement if the damages are the direct result of a physical injury or illness. Tax-free settlements are reached either through negotiation with the insurance company out of court or settlements reached by a judge or jury.

On the other hand, physical injuries resulting from emotional distress, like migraines or ulcers, are taxable.

When Taxes are Collected for Settlements from Personal Injury or Sickness Damages

If someone is awarded a settlement for personal injuries or an illness and did not take an itemized tax deduction for those medical costs, that settlement is not taxable and does not need to be included as part of an income on any tax documents.

Examples of when someone in these cases may have to pay taxes include:

• If a portion of the settlement paid for medical expenses that were deducted from a taxable income, that should be included in the taxable income.
• If medical expenses were deducted in previous years for a tax benefit using Form 1040, part of the settlement may be taxed.
• If a tax deduction was taken for more than one year, taxes would need to be paid on this portion of the settlement on a pro-rata basis.

When Taxes Are Collected for Settlements from Pain and Suffering Damages

When a victim of an accident has suffered mental or emotional distress because of a personal injury accident, they may be awarded compensation for those pain and suffering damages, which may be taxable income comparable to the compensation received for injuries or sickness.

The amount of the personal injury settlement that is required to be reported with a victim’s income taxes, however, can be reduced if:

• They paid for related medical expenses and did not deduct the costs from taxes.
• Medical expenses were deducted for mental anguish, but no tax benefit was received.

If pain and suffering damages are reported on taxes, a statement needs to be attached on the tax return, which includes the entire settlement amount, minus any eligible medical costs that have not yet been deducted, or medical expenses that were deducted without a tax benefit received.

When Taxes are Collected for Settlements from Property Damage

If someone is in a car accident, part of the personal injury settlement could include compensation for any property loss damages, such as having a car repaired or replaced. Typically, property loss damages are tax-free.

However, there is one exception. If that compensation for property damages exceeds the estimated loss of value, the excess amount will be accounted for as taxable income.

When Taxes are Collected for Settlements from Punitive Damages

When someone is injured in a personal injury accident by a defendant who intended harm, had an intentional disregard for public safety, or the case involved gross negligence, they may be awarded punitive damages, in addition to any compensatory damages (medical expenses, lost wages, pain and suffering, and more).

Punitive damages are always taxed because these damages are assigned by a court to punish the defendant, not to compensate the plaintiff for any losses caused by injuries. Punitive damages can be reported as “other income” on a tax return.

How to Maximize a Personal Injury Settlement from Taxes

It is essential to know how to maximize a personal injury settlement before the case is resolved because the settlement may be partially or completely taxable on a tax return.

The process can be confusing, since every case is different, so it is beneficial to rely on the professional expertise of a licensed accountant and a personal injury attorney, or to contact the IRS.