After a win in court for a personal injury claim, people are typically relieved to obtain the money they need to move forward and cover the expenses from their accident. However, they may not think about how much of that award they need to put back for taxes.
Fortunately, the IRS does not tax all damages from a personal injury judgment.
Type of damages
U.S. News and World Report explained that whether a person owes taxes depends on if the damages they received were for physical injuries. The government does not tax money received for physical injuries or costs related to those injuries, such as medical care.
A person may have to pay taxes on damages he or she receives due to emotional distress in some cases. If the distress is a direct result of the physical injuries the person sustained, then the IRS does not tax that portion of the award. If the emotional distress is not related to physical injuries, then tax may apply.
A person will face taxation for any damages the court awards to cover lost wages or other monetary losses suffered as a result of the accident. However, there is an exception again. If the person loses wages or earnings due to the physical injuries from the accident, then that portion of the award is not taxable.
Confusing rules
Courts make their own distinctions of how to categorize the damages in any given case. It may not be straightforward to determine the relationship between the physical injuries and each of the other aspects of the award. A judge or jury may not understand the tax consequences of assigning each category of damages.
During the case, a person may be able to show that the reason for the damage award has its basis in the physical injuries from the incident so that money needed to cover the losses from the accident does not disappear at tax time.
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