Are Settlements Taxable?
After you have filed a lawsuit, both parties may enter into settlement negotiations. Settlement negotiations are made after discovery. Discovery is the time when both parties work to gather as much information as possible about the accident. Whether it is a car accident, truck accident, motorcycle accident, etc, the lawsuit will require a discovery time period.
It is important that you have highly qualified attorneys on your side to enter into settlement negotiations with an insurance company and the defendant. Insurance companies will always try to downplay their liability to avoid paying out large amounts of money. When this occurs, they will resort to different tactics such as manipulating the victim into falsely admitting liability. A person who does not have an attorney may easily get manipulated by an insurance company to say some statements on the record that could potentially harm their case.
When settlement negotiations happen, both parties work to find a damage amount that both could agree to. This settlement negotiation amount should take into account all of the damages that the victim suffered. Examples of damages include lost wages, future lost income, emotional distress, past medical bills, property damage, and any future medical treatments that the victim may need from the accident.
One of the most common questions we are asked by our clients prior to going into settlement negotiations is whether settlement amounts are taxable. Usually, almost any amount is subject to taxes in California. The IRS is the department responsible for collecting taxes in California. Almost every single type of income is considered taxable by the IRS. The settlement amount therefore will be considered income. Since it is income, it may be taxable, and the victim may have to pay taxes on it. However, there are some exceptions where you may not have to pay taxes.
Under 26 USC § 61(a), the IRS states that almost every type of income is taxable, regardless of source. An exception to this is personal injury and physical injury. This means that if you have received any type of income to address your physical injury, it is not taxable.
Personal injury lawsuits are lawsuits that involve some type of negligence the defendant engaged in that caused the victim to suffer injuries. Personal injury lawsuits involved bodily injury. Bodily injury lawsuits fall under “observable bodily harm” which is an exception to income taxes. Therefore, any money recovered from settlement negotiations is not taxable.
However, if your car accident attorney has a set fee, the settlement amount could be reduced by your attorney’s fees. Our car accident attorneys work on a contingency basis, and we do not collect compensation unless we win a settlement or judgment. This means that after we come to some type of settlement agreement with the insurance company, we will deduct our fees from that settlement amount. For more information on contingency fees, contact our attorneys today.
Are Lost Wages Taxable?
Lost wages are damages that the plaintiff suffered from the injuries that deal with the amount of time the plaintiff had to take from work. Past lost wages refer to the number of hours the plaintiff missed out on from work, and instead went to seek treatment for their car accident injuries. If you receive a settlement amount that is meant to compensate you for your lost wages, then you most likely will have to pay taxes. These taxes include Social Security taxes, which is the standard taxes paid if you were to actually go into work during those hours.
Are Medical Expenses Taxable?
Visits to health care providers for any physical injuries you have suffered or emotional distress caused by the accident are not taxable if you did not make an itemized deduction in the previous years. But, if you did end up settling and were compensated for your past medical expenses, you may be required to pay taxes on those medical expenses. Tax preparers call this the “tax benefit” rule. Examples of medical expenses include:
- Doctor’s visits
- Prescription medication
- Imaging (X-rays, CAT scans, MRIs)
- Physical therapy sessions
- Hospital stays
Are Emotional Distress Expenses Taxable?
If you receive a settlement amount to compensate you for the emotional distress you have suffered, the settlement amount will not be taxable if the settlement amount is meant to compensate for some type of emotional distress that was caused by a specific physical injury that occurred from the accident. If the emotional distress is not linked to a physical injury, then the settlement will most likely be taxed. Therefore, your attorney must be able to make these distinctions for you and determine what the settlement amount is meant to compensate.
Are punitive Damages Taxable?
Prior to filing your taxes, our car accident attorneys recommend that you seek advice from an attorney to determine what your settlement amount covers, and what it is meant to compensate you for. Other than that, we also recommend that you speak to a tax accountant, simply because settlements and judgments could get very difficult when filing as an income. There are several other court documents that you must also have to fill out when doing your taxes.
One of the most common mistakes that tax filers make is claiming the lump sum against the defendant when there were two claims made against the defendants. For example, if you made a claim against the defendant for negligence and another intentional action, these will be filed as two different claims. If you recovered for both of these claims, you most likely will not have to add them together in a lump-sum when doing your taxes. Instead, you may have to file it separately, since they were separate lawsuits.
If you would like more information on settlements, contact our top-rated attorneys for a no-obligation consultation. Our consultations are always free, and our attorneys will always work to make sure that our clients understand every single step of the settlement process. We always want to make sure that our clients are constantly informed with every single update that involves their case. Other law firms may make decisions on their own and may not communicate to their clients. Communication is a top priority for our firm, and we work aggressively fighting against insurance companies in your favor. Our attorneys at Megeredchian law understand just how difficult it may be to pay taxes, and how stressful it may be at the mention of the IRS. Just making one mistake on your taxes could result in high penalties and fines, possibly even jail time.
Call us today to schedule a free consultation, where we will be able to answer all your questions and concerns regarding the settlement and the next steps you should take after receiving the settlement offer.