Are Punitive Damages Taxable?

Personal injury attorneys hear a lot of the same questions from different clients. One that is asked quite frequently is “Are punitive damages taxable?” Like most legal issues, the answer to this question isn’t black and white. The laws governing personal injury claims are complex and there are several exceptions to the rules that make it even more confusing.

What Are Punitive Damages?

Punitive damages are awarded in a lawsuit when the defendant committed malicious, oppressive, violent, fraudulent, or grossly reckless actions. These damages are often awarded as a punishment to the defendant. If you are awarded punitive damages in your personal injury case, they also serve as a reward for what you’ve endured.

Punitive damages aren’t often awarded. When they are, they are in addition to a compensatory damage award. The latter type of damages is tied to the “Made Whole Rule.” They are meant to place a financial value on what you have lost due to your injuries. Other types of damages awarded in a personal injury case may include:

• The Cost of Medical Treatment
• Compensation for Loss of Income
• Pain and Suffering
• Emotional Distress
• Loss of Enjoyment
• Loss of Consortium

Any of these damages may, or may not, apply to your case. The most common cause of personal injuries is car accidents. If you are seriously injured by another driver, you could experience flashbacks of the accident. Sometimes people experience severe anxiety, insomnia, or post-traumatic stress disorder when their injuries are severe. They can even develop changes in their personalities, which can destroy their relationships and cause them to lose interest in things they used to enjoy.

Since the primary reason for punitive damages is to punish the defendant by “hitting them in the pocketbook” these awards are often significant. The first question many people ask is “How much is my personal injury case worth?” Several factors will determine the answer including the severity of your injury, your damages, and how your injury has impacted your life. It also depends on whether the at-fault party caused your injury due to gross negligence or through a willful act. If that’s the case, you might be awarded punitive damages. The next question becomes “Are punitive damages taxable?”

State laws largely determine the time limits for filing claims, caps on damages, and the types of damages a person can request. Generally, the settlement you receive in a personal injury case cannot be taxed at the state or federal level. Any benefits you receive for any of the damages listed above, including compensatory damages, are not taxable. One exception to this rule is that for a physical injury or sickness that resulted from a breach of contract.

Another exception is on interest paid on benefits. You will earn interest on your compensation between the time that you file your personal injury claim until you receive payment. While the amount of the award isn’t taxable, the interest you receive is.

The third exception to the rule involves taxing punitive damages. Punitive damages are always taxable. Requesting a separation of the verdict into compensatory and punitive damages is a common practice among personal injury attorneys. This protects you from being taxed on compensatory damages.

Defining Personal Injury

A personal injury is one that occurs to your body, mind, or emotions. To file a personal injury claim, another person must have caused your physical or psychological injury.  If you suffer from depression, anxiety, or insomnia because of your accident and injury, you can request damages for these conditions. These damages, along with your medical treatment, are part of your personal injury claim.

These damages are considered differently when it comes to the issue of taxability. Although you can file a personal injury claim for these injuries, the emotional injury must have arisen from a physical injury before it is tax-exempt.

Talk to your attorney about all your injuries to determine what is taxable and what isn’t. If he can prove that even a portion of your injuries is physical, you may not have to pay taxes on any of your settlement. Otherwise, it might be in your best interest to make two claims against the at-fault party. One will be for the physical injuries that are tax-exempt. The other will be for the emotional injury that is not. This will allow you to make as much of your settlement non-taxable as possible.

How Your Actions or Inaction Affect Your Damages Award

In addition to paying taxes on punitive damages, your role in your injury can also affect your damages. For example, California’s comparative negligence law allows for both parties to be partially at-fault in an accident. For example, if you are found to be 10% at-fault for the accident, you can only collect 90% of the benefits awarded. If your judgment is for $100,000, that’s $10,000 you won’t collect.

Even if the other party is 100% at-fault, you could have your damages reduced by failing to mitigate the damages. The law expects you to take any reasonable steps to minimize your financial impact. The most obvious example is getting medical treatment for your injury immediately after the accident. If you don’t and your injury gets worse, you could end up collecting a lot less.

Never assume the other side of your lawsuit doesn’t know what you are doing to mitigate your damages. Medical records are typically a big part of a personal injury lawsuit. The defendant’s insurance company will make every effort to find reasons for having their payout to you reduced. If you fail to get medical treatment, you give them the opportunity to claim you weren’t really injured. They could also argue that it wasn’t the accident, but your actions or inactions that made your injury so severe.

How to Report Punitive Damages on Your Taxes

Not only are punitive damages taxable, but you could end up paying even more in fines if you fail to report them to the IRS. You will need to list them as “Other Income” on line 21 of the Form 1040 Federal Income Tax Return. The instructions provided by the IRS state that punitive damages must be reported even if you received them for a personal physical injury or physical sickness. They also recommend making estimated payments if your expected tax will be $1,000 or greater.

Another factor that could complicate your tax return is your health insurance through the Health Insurance Marketplace. Punitive damages are taxable income, which changes your total income for the year or years you receive compensation. If you receive a tax credit towards your health insurance, this may increase your tax liability.

If you aren’t sure how to handle reporting your taxes, your attorney can help you distinguish between the types of income that are taxable and those which are not. For questions about your tax credit, ask your accountant or tax preparer what income should be included and how to report it. The more money you are awarded, the higher the fines and penalties will be if you don’t report it.

Preparing for Your Personal Injury Case

If you think you deserve punitive damages for what you’ve been through, your attorney will include the request in your claim. It’s important to keep your request in proper perspective with the rest of your case. Some research shows that punitive damages are awarded in less than 4% of all civil jury verdicts.

Another thing to keep in mind is that most personal injury cases are settled before or during a trial. Both parties benefit when they come to an agreement instead of dragging out the court case. Punitive damages are only awarded at the outcome of a trial. Unless you are confident of winning, you may want to consider pursuing a punitive award in your case.

Don’t lose sight of the main reason for your personal injury claim. Even minor to moderate injuries result in high medical bills. More serious injuries sometimes need ongoing medical treatment. If another person or entity is responsible for your injury, you have the legal right to pursue compensation.

To get the best outcome for your case, find a reputable personal injury attorney. Schedule a consultation and find out if you have a legitimate claim. Many people think that lawyers take on any case just to take the client’s money. The truth is, personal injury attorneys offer free initial consultations and they don’t charge anything until they win your case. It’s in their best interest and yours to only take on cases they have a good chance of winning.

Once the attorney looks over the evidence in your case, he will calculate the damages. Unless the defendant behaved in a way consistent with the requirements, he probably won’t include punitive damages. If he does, don’t count on winning them. Instead, keep your focus on proving your case and winning a settlement to cover the cost for your injuries.

“Are punitive damages taxable?” is just one of the many questions you need answered about your personal injury case. Get the answers you need now from a successful San Diego personal attorney today. Contact Batta Fulkerson and schedule your free case evaluation.

Punitive Damages by Nick Youngson CC BY-SA 3.0 ImageCreator