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ARE PERSONAL INJURY SETTLEMENTS AND RECOVERIES TAXABLE?

In general, compensatory damages awards and settlements, whether by lump sum or periodic payments, "on account of personal physical injuries or physical sickness" are not subject  to federal or state income tax (that is, physical injury compensatory recoveries are excluded from taxable income). Internal Revenue Code §subdivision (a)(2); California Revenue & Tax Code §17131.

If an action has its origin in a physical injury or physical sickness, all damages that flow from such injury or sickness are treated as payments received on "account of personal physical injuries or physical sickness." 

This rule of no taxation applies even if recipient of the damages is the not the injured party. For example, compensatory damages for emotional distress arising from a spouse's physical injury or sickness are not taxable. (H.R. Conf. Rep. 104-737,1996 U.S. Code Cong. & Adrnin. News 1677, §5.).

Why is it not taxable?  Because money paid for property damage and medical bills is offset by a loss.  Further, money paid for general damages such as "pain and suffering" in a personal injury claim is generally not taxable because it is compensation for a loss intended to make one whole again.  In other words, the plaintiff or injured party has not "gained" anything, but he or she has simply been made whole again.

Exceptions.  

Money paid for punitive damages is taxable in most cases even if it is connected to a physical or nonphysical injury or sickness [see IRC section 104(a)(2)].

While money paid for lost income is taxable, generally such is not taxable in most personal injury claims especially where the proceeds are not specifically categorized.  But if a portion of your settlement was specifically designated as compensation for lost wages, that portion would likely be taxed.

In most cases, once the personal injury settlement money is placed in a bank account, the interest earned on the money is taxable.  But their are exceptions as with certain kinds of tusts, for example, a Special-Needs Trust or a Pooled Trust.

There are other exceptions to nontaxability that may apply as well.  

See IRS publications for guidance.

Tax laws are complicated and changing.  This article is not tax or legal advice.  To determine whether or not and how the above tax laws apply to your particular situation, you are urged to seek counsel from an experienced and knowledgeable tax professional or attorney with knowledge of tax law before accepting a settlement.  

If you've been injured, contact Christian personal injury lawyer Matthew B. Tozer.

Disclaimer: The information provided in this article is informational, only. The subject matter and applicable law is evolving and/or constant state of change.  This advice is based on Federal and California law.  No legal advice is given and no attorney/client or other relationship is established or intended.  The information provided is from general sources, and I cannot represent, guarantee or warrant that the information contained in this website is accurate, current, or is appropriate for the usage of any reader. It is recommend that readers of this information consult with their own counsel or tax professional rather than relying on any information on this website.


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