For the most part, the IRS will not touch your personal injury settlement in Virginia. The monies obtained in a personal injury case aren’t viewed as “income,” but rather reimbursement for your losses. As such, settlement monies awarded for any physical injury are always exempt from federal and state taxation. However, there are some categories of damages that are not exempt.
Furthermore, you will not have to pay taxes on settlement money that is recovered for emotional distress (if the anguish arises from a physical injury), or hospital and medical expenses.
If the proceeds you secure for mental and emotional anguish do not originate from a personal physical injury or physical ailment, you must declare these damages to the IRS. However, you can deduct the amounts paid for medical care to treat emotional distress.
Because laws on settlement taxability are subject to change, it’s imperative to discuss the situation with your personal injury attorney before the case is resolved.
Lost wages and income awards are taxable
The portion of the settlement you receive for “lost profits from your business,” or “lost wages” (including severance pay and back pay), are subject to normal income tax. If you are self-employed, this amount needs to be included on line 21 of Form 1040, for “business income.”
Deducted medical expenses
Medical expenses are a huge component of most personal injury settlements. If you itemized and deducted medical expenses and were later compensated for this amount, you will have to reimburse these tax benefits. If you paid these costs over more than a year, you must distribute– on a pro-rata basis– the part of the proceeds for medical expenses to their respective years.
Punitive damages, meant to punish the defendant for reckless and wanton conduct, are relatively uncommon in personal injury claims. If the court awards punitive damages, you will have to pay federal income taxes.
Interest earned / dividends
The IRS can tax any dividends and interest earned on a personal injury settlement, regardless of its origin. Large, lump-sum settlements can generate a great deal of interest income. Therefore, it’s wise to ask your personal injury lawyer about the best methods for mitigating tax consequences. In some situations, it may be more advantageous to choose a structured settlement that generates periodic, smaller payments on a regular schedule.
Contact us at Rutter Mills for a free consultation
There are various ways to reduce your tax burden on personal injury settlement money while staying compliant with the law. Allocating your damages in a strategic manner can be advantageous, but every case is different.
For additional guidance, contact our team of personal injury lawyers at Rutter Mills. We provide compassionate, client-focused representation on a contingent-fee basis, meaning we advance all litigation costs and are only paid after recovery is made on your behalf. Reach out to arrange a free consultation today.
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