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After receiving compensation in a personal injury case, there are many things to consider and manage. One of those things is determining the tax liability for the settlement.

Your personal injury compensation may be taxable and may not be taxable. The United States tax code is confusing, and taxes related to personal injury compensation are no exception. Here’s what you need to know to better understand the tax burden of a personal injury settlement .

What is compensation for?

The first aspect to consider when determining the tax liability is the purpose of the monetary compensation. Different types of compensation incur different tax obligations .

For example, your settlement may be for medical bills, lost wages, pain and suffering, emotional distress, or other damages. Once you know the type of payment you are going to receive, you can check the tax liability for that type of settlement.

Medical bills

Generally, compensation for medical bills is not taxable. For example, consider a scenario in which a customer slips and falls on a broken piece of glass on the floor of a store.

Client breaks arm resulting in $ 10,000 in medical bills. If the store agrees to pay you $ 10,000 for your medical bills, this money is exempt from tax.

Deductions in previous years for medical expenses

When you are dealing with the tax consequences of a personal injury settlement, another thing to pay attention to is medical expenses in previous years. If you have medical bills, you may have taken itemized deductions from those bills to reduce your tax liability. This is allowed under tax law.

However, once you receive a settlement, you should be aware of the fact that your tax liability may have changed. Any portion you deducted in a prior year should now be included as taxable income. You must report this as “other income” on line twenty-one of your 1040 form.

Emotional distress and pain and suffering

Emotional distress payments are not taxable if they result from a personal injury. In the case of the client who sustains a broken arm in a fall, if she recovers from emotional distress, her recovery is not taxable.

However, if the victim is not injured and recovers only from emotional distress, the recovery is taxable. If you spend part of the recovery on mental health care, you can deduct that part from your taxable income. It’s important to save your receipts in case you ever need to check.

Lost wages

Payments for lost wages are generally taxable. These payments are also subject to federal social security and Medicare taxes. You must report this type of recovery on line seven of your 1040 such as wages, salaries, tips, etc. If your recovery is for loss of business income, you must report this as business income.

What if I have a judgment instead of a settlement?

The tax laws of the United States treat a judgment in the same way as a settlement. That is, it does not matter if the court or jury orders the other party to pay or if a person agrees to settle. The tax laws are the same.

What about property damage?

Generally, payments for the destruction of property are not taxable. For example, consider a scenario in which a car collides with a mailbox, part of a house, and trees. The owner recovers $ 2,000 for the reduced value of the property.

Because compensation is for property that is now worth less than it was before, payments are not taxable. If the settlement is more than the decrease in property value, the difference is taxed as capital gains.

Interest income

Even if the recovery itself is not taxable income, the interest you receive when you invest the recovery could be considered taxable. For example, you recover $ 50,000 for pain and suffering. Then you invest the money and earn $ 2,000 from the investment.

You must pay taxes on the $ 2,000 of interest. You must report this money as interest income on section 8a of your 1040 form.

Punitive damages

Punitive damages are taxable regardless of the reason you receive them. That means that even if you are awarded punitive damages due to conduct related to emotional injuries, the damages are taxable.

Because the purpose of punitive damages is to punish misbehavior that is not necessarily criminal, punitive damages are not treated by the IRS as compensation for any particular loss. This type of compensation goes below line twenty-one for “other income” on your 1040 form.

Tips to keep your tax burden low

You can work with your injury attorney to make sure your taxes are as low as possible for any settlement you may receive. One thing to keep in mind is that you may need to make estimated tax payments on your settlement. Without estimated payments, you may have fees and penalties when you file.

There are other ways to minimize your tax obligations. Your personal injury attorney can help you create an agreement that specifies the specific losses for a recovery. That can change the way the IRS taxes money.

Additionally, you can structure your settlement over several years as a way to reduce overall liability. You can work with your attorney or tax professional for other ways that you could structure or reverse the recovery to minimize your liability.

What about Nevada taxes?

Nevada does not have a state income tax. Instead, the state relies on sales and use taxes for income. It is always a good idea to check with a tax professional to find out if your settlement requires you to take any action regarding state taxes.

How a lawyer can help

It is important to work with a Las Vegas personal injury attorney as soon as possible when you suffer a personal injury. In addition to helping you navigate the legal system and negotiate a settlement, your attorney can also ensure that you take tax consequences into account as you work together to navigate the court system.

Taxes can be confusing and can end up consuming a significant portion of the money you need for your recovery without proper planning and consideration. If you or a family member has suffered a personal injury or if you have questions about tax liability related to fixing an injury, schedule your free consultation today.

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