Money received from personal injury settlements and verdicts is considered income. Is it subject to federal income tax? This is one of the most common questions the Connecticut personal injury lawyers at Injuredct.com get asked.
The short answer is no. Most likely, you won’t have to pay federal income tax on the money you get from a personal injury settlement. There are some exceptions, however.
The way taxes are taken care of for personal injury settlements depends greatly on the type of compensation and the Internal Revenue Code (IRC) rules.
The United States Tax Code Governs Personal Injury Settlements.
Under Section 104(a)(2) of the IRC, personal injury settlements are generally not taxed. It reads: “Gross income does not include… the amount of any damages (other than punitive damages) received … because of personal physical injuries or physical sickness.”
There is an excellent public policy reason for this rule. We want to make sure that people who get compensation for personal injuries or physical illnesses are put back in the same financial position they were in before the accident.
Taxing money for personal injuries would not make them “whole.” A personal injury settlement in Connecticut is designed to compensate for a loss.
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When Can the IRS Require Personal Injury Settlements to Be Taxed?
There are a few cases and situations in which personal injury payments may be taxed:
- Punitive damages: If the settlement includes an award of punitive damages, those damages are taxable and should be reported as “Other Income” on Line 21 of Form 1040, regardless of whether they are linked to a physical injury or illness.
- Emotional distress or mental anguish: If the compensation received was only for emotional distress or mental anguish that wasn’t caused by a physical injury or illness, it is taxable. But if the emotional or mental pain is caused by a physical accident, the settlement is still not taxed.
- Interest on the settlement: Any interest that builds up on the settlement amount before it is given to the recipient is considered taxable income.
Are Out-of-Pocket Expenses or Economic Losses Taxed?
- Lost wages or lost profits: Most of the time, compensation for lost wages or lost profits is taxed and subject to employment taxes, even if it comes from a personal injury settlement. This money should be written down on Form 1040, Line 7.
- Reimbursement of medical costs that were already deducted: If a recipient deducted medical costs linked to the injury on their tax return and then got that money back through a settlement, the amount they got back must be reported as taxable income.
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Are Workers’ Compensation Payments Taxed?
Workers’ compensation agreements are also subject to the tax laws. Workers’ compensation in Connecticut is a no-fault system designed to make sure employees who get sick or hurt on the job can still receive income.
These benefits are meant to help pay for hospital bills, lost wages, retraining for a new job, and, in some cases, compensation for permanent disabilities. Under Connecticut’s rules about workers’ compensation, settlements are not usually taxed as income.
According to Section 104(a)(1) of the Internal Revenue Code (IRC), “gross income does not include amounts received under workmen’s compensation as compensation for personal injuries or sickness.”
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When Are Workers’ Compensation Cases Taxed?
This means that most workers’ compensation benefits in Connecticut are not taxed. The main reason for this exclusion is to ensure that workers who get hurt don’t have to pay more taxes on the benefits that are supposed to help them get better and return to work.
There are, however, a few cases in which taxes may be applied to workers’ compensation benefits in Connecticut:
- Social Security Disability Insurance (SSDI) offset: If a worker gets both workers’ compensation and SSDI benefits, a part of the workers’ compensation benefits may be reduced or “offset,” resulting in an amount that is subject to federal income tax. This happens when the worker’s total benefits are worth more than 80% of his or her average earnings before the accident.
- Retirement or pension benefits: If an injured worker gets retirement or pension benefits based on their age, length of service, or previous contributions, and those benefits are paid for in whole or in part by workers’ compensation, the retirement or pension benefits may be considered taxable income.
What Taxes does the Estate Pay in Cases of Wrongful Death?
When a wrongful death estate brings a personal injury claim, how the settlement is taxed depends on what kind of damages are awarded and how they are divided. The Internal Revenue Code (IRC) says that some types of losses are not counted as gross income, while others are.
- Damages that are not taxed: According to IRC Section 104(a)(2), the gross income of the estate does not include compensation for the decedent’s physical harm, pain, and suffering before death. This is because these damages are meant to pay the estate for the pain and suffering of the decedent, which would not have been taxed if they had been given directly to the decedent.
Wrongful death damages that are taxable:
- Lost wages and earnings: When paid to the estate, compensation for the decedent’s lost wages or earnings, which would have been taxable had the decedent lived, is usually taxed as income.
- Punitive damages: If the deal for a wrongful death includes punitive damages, the estate usually has to pay taxes on these amounts. Punitive damages are not meant to make up for the harm done to the victim. Instead, they are meant to punish the wrongdoer.
- Interest on the settlement: Interest that builds up on the settlement amount before it is paid to the estate is considered taxable income.
If you have more questions, then please give us a call at 855-CT-Legal or visit Injuredct.com.