Do You Pay Taxes on Personal Injury Settlements?

After the stress of an injury and the long wait for a personal injury settlement, the last thing anyone wants is uncertainty about taxes. If you’ve recently received — or are expecting — a personal injury settlement in Texas, you might wonder whether your money will be taxed. The good news is that, in many cases, personal injury settlements are not taxable. However, there are important exceptions you should be aware of.

Our experienced personal injury lawyers understand all the tax implications and have relationships with knowledgeable tax and financial experts who can guide you with proper financial planning after your case is won. In this article, we’ll break down how Texas and federal tax laws treat different parts of a personal injury settlement so that you can move forward with clarity and peace of mind.

Are Personal Injury Settlements Taxable?

No. Most personal injury settlements are not taxable at the federal level, but there are important exceptions that every injury victim should understand. The Internal Revenue Service (IRS) generally does not consider compensation for physical injuries or physical sickness as taxable income. This means that if you receive money for medical expenses, physical pain and suffering, or other compensation directly related to your physical harm, you typically won't need to pay taxes on these amounts, as IRS Publication 4345 explains in detail.

Taxable Components of Personal Injury Settlements

The following components are typically considered taxable income by the Internal Revenue Service:

• Punitive damages: Unlike compensatory damages that reimburse you for actual losses, punitive damages are designed to punish the defendant for gross negligence. The IRS considers punitive damages taxable income, regardless of whether they're awarded in a physical injury case.
• Interest on settlements: If your settlement includes interest accrued between the injury and the settlement payment, that interest is taxable.
• Lost wages or lost income: Compensation for lost wages or income is generally taxable, as it replaces income that would have been taxed had you earned it normally.
• Emotional distress not stemming from physical injuries: If you receive compensation for emotional distress that isn't directly connected to physical injuries or physical sickness, that portion may be taxable.
• Settlement for non-physical injuries: Settlements for cases that don't involve physical harm, such as defamation or employment discrimination, are typically taxable.

Non-Taxable Components of Personal Injury Settlements

Fortunately, a significant portion of most personal injury settlements is exempt from taxation:

• Medical expenses: Compensation for medical costs related to your injury is generally not taxable, unless you previously deducted these medical expenses from your taxes and received a tax benefit.
• Physical pain and suffering: Compensation for physical pain and suffering directly related to your physical injuries is typically not taxable.
• Emotional distress from physical injuries: When emotional distress damages stem directly from physical injuries or physical sickness, they are usually not taxable.
• Loss of consortium: Damages for loss of companionship or consortium related to physical injuries are generally not taxable.
• Property damage: Compensation that simply reimburses you for damaged property (such as your vehicle in a car accident) is usually not taxable. However, the excess may be taxable if you receive more than the property's adjusted basis.

Generally, any portion of your personal injury settlement that is considered taxable income is taxable in the year you receive the settlement funds. This is consistent with how other forms of income are taxed.

Texas-Specific Tax Considerations for Personal Injury Settlements

Texas residents have some advantages when it comes to personal injury settlements and taxes:

• No state income tax: Since Texas doesn't have a state income tax, you won't need to worry about paying state taxes on any portion of your personal injury settlement. However, you may still be responsible for federal taxes on the taxable portions mentioned above.
• Workers' compensation: In Texas, workers' compensation benefits for work-related injuries are generally not taxable at the state or federal level.
• Structured settlements: Texas follows federal guidelines regarding structured settlements. If you receive your personal injury settlement through periodic payments rather than a lump sum, the tax treatment remains the same — compensation for physical injuries remains non-taxable, while other components like punitive damages remain taxable.
• Attorney's fees: In Texas personal injury cases, attorney's fees are typically paid from the settlement amount. The tax treatment of these fees can be complex. For the non-taxable portions of your settlement, the attorney's fees are simply part of the non-taxable amount. However, for any taxable portions (like punitive damages), you may be able to deduct related attorneys' fees.

The team of exceptional personal injury lawyers at the Omar Ochoa Law Firm is readily available to assist you with the tax implications of your personal injury settlement. As a local firm, we possess a detailed understanding of Texas laws relevant to your case.

Know the Tax Rules with the Omar Ochoa Law Firm

While most personal injury settlements for physical injuries or sickness are not considered taxable income at the federal level, certain components, such as punitive damages, interest, and compensation for lost wages, may be subject to taxation. In Texas, residents benefit from the absence of state income tax, but federal tax obligations still apply to taxable portions of settlements.

If you've been seriously injured by someone else’s negligence, the Omar Ochoa Law Firm is committed to winning the most money possible for our clients. Contact us today for a free consultation!