You’ve been injured by someone else’s negligence. You aren’t the type of person to sue, but the insurance company for the negligent party is not willing to pay you to fully compensate you for your losses. You end up searching for and hiring a personal injury attorney in Las Vegas, and after making a claim, perhaps initiating a lawsuit, and maybe even going through an arbitration or trial, you are awarded damages.
Maybe that award is in the form of an arbitrator’s decision, a judge’s order, or a jury verdict. Maybe it was the result of a voluntary settlement either after a mediation or merely informal negotiations. It’s possible you even got an award of attorney’s fees. Regardless of their source, the other side is now going to compensate you for your damages.
Part of the total award goes to your attorney. Part of it goes to reimburse lienholders, like medical providers or your health insurance. The balance goes to you.
So what of the IRS? How is your award treated? Is it taxable?
The IRS decreed that “gross income means all income from whatever source derived” unless a certain exception applies. 21 U.S.C. § 61. Sections 101–40 list those exceptions, and § 104 in particular applies to personal injury awards.
For the most part, no, your personal injury award is not taxable. But like everything else related to the IRS, what is and what is not taxable is complicated. The answer depends on what you’re being compensated for, which requires an analysis of the components of your settlement.
Compensation for Physical Injury or Sickness Is Not Taxable
To the extent your award is intended to compensate you for losses resulting from physical injury or sickness, it is not taxable. The good news is that in most personal injury cases, the bulk of your award (if not all of it) is compensation for physical injury or sickness. Thus, it is not taxable, meaning you don’t include the proceeds as part of your reported income.
However, if you paid medical bills related to your injuries, and you claimed them as deductions in prior years’ tax returns, then any portion of the settlement proceed intended to reimburse you for those medical bills must be reported as income. In other words, you can’t benefit from the same medical bills twice—either you get the deduction one year and claim the income for reimbursement another or you do neither.
Compensation for Emotional Distress and Mental Anguish May Be Taxable
Compensation for emotional distress and mental anguish is a little more complicated, though in most personal cases, it, too, will be non-taxable.
The rule is that if the emotional distress and mental anguish are derived from physical injury or sickness, then they are considered extensions of the physical harm and are not taxable. However, if the compensation you get for these psychological stresses are wholly independent from any physical injury or sickness, then it is taxable, and you have to report it as income.
If you’ve paid medical expenses related to your psychological damages, and those were not previously deducted, you can get a credit for them when you file your taxes. You can also get a reduction to the extent you deducted the medical expenses, but they provided no tax benefit.
Lost Wages Are Sometimes Taxable
Reimbursement for lost wages if taxable if it is received in a case not related to personal injuries, like an employment-discrimination suit or wrongful termination case.
If, however, you lost wages “on account of personal injuries,” then they are not taxable. That means that if you missed work because of your injuries, then reimbursement for the lost wages does not have to be reported. See Commissioner v. Schleier, 515 U.S. 323, 329–30.
Loss-in-Value of Property Are Not Taxable—To a Certain Extent
If you received a property settlement for the loss in value of your personal property—like reimbursement for damage done to your car—it is not taxable and does not need to be reported as long as the loss in value is less than the adjusted basis of your property. Otherwise, it is considered income and must be reported.
Interest Is Taxable
If your award comes with interest, then whatever portion of that award is designated as interest must be reported and is taxable.
Punitive Damages Are Taxable
Punitive damages are those designed to punish the wrongdoer. They are typically only available in cases where there is some sort of malice—like when someone harms you intentionally. They are also available in certain categories of other cases, like product defects. Punitive damages awards are taxable and must be reported unless you get an award for punitive damages for wrongful death in a state where only punitive damages can be awarded in wrongful death cases.
If you have been in an accident or were otherwise injured by someone else’s actions, consult with an experienced and skilled personal injury attorney.
For more information about whether an award is taxable, see the IRS Lawsuits, Awards, and Settlements Audit Techniques Guide and the IRS flyer, Settlements—Taxability.
Zachariah B. Parry is an attorney and founding partner at the law firm Parry & Pfau and is an adjunct professor who teaches torts, contracts, and Nevada practice and procedure for UNLV’s paralegal program. He can be reached at 702-912-4451 or firstname.lastname@example.org.