If you have recently received a personal injury settlement in Georgia, you may be wondering how much of it you will owe taxes on. Personal injury settlements often include compensation for medical expenses, lost wages, pain and suffering, and other damages. However, not all of these settlement amounts are taxed the same under federal and Georgia state tax laws.
It is important to understand which parts of your personal injury settlement are considered taxable income by the IRS and Georgia Department of Revenue. Failing to report taxable portions of your settlement properly can lead to tax evasion charges, audits, penalties, and interest payments. An experienced personal injury lawyer can help you maximize the amount of your settlement that is tax-free while remaining compliant with tax laws.
What Makes a Personal Injury Settlement Taxable?
According to the Internal Revenue Code, all income received is taxable unless a specific exemption applies. Most of the exemptions for personal injury compensation stem from IRC Section 104(a)(2). Under this code, plaintiffs can exclude compensation for physical injuries or physical illnesses from their taxable income.
This includes compensation for:
- Medical expenses like hospital visits, surgery, physical therapy, medication, and transportation for medical care
- Lost wages from being unable to work during recovery
- Pain and suffering resulting from the injury or illness
- Emotional distress like PTSD from trauma
However, Section 104(a)(2) does not exclude all personal injury settlement amounts from taxation. Plaintiffs typically must pay taxes on compensation for non-physical injuries or punitive damages.
Taxability of Different Settlement Components
Let’s take a closer look at how federal and Georgia state tax laws apply to the various components often included in personal injury settlements:
Compensation for Physical Injuries
Compensation for medical treatment, lost income, and other economic damages directly stemming from a physical injury or illness is non-taxable. The rationale is that this part of the settlement simply restores plaintiffs to their prior financial state before the incident.
Compensation for Emotional Distress
Under the IRC Section 104(a)(2) exemption, compensation for emotional distress like depression or PTSD is also tax-free as long as the emotional distress directly resulted from physical injuries sustained in the incident.
Compensation for Property Damage
If any part of your settlement is meant to cover property damage or loss, it will likely be taxable. Property damage does not qualify as a “physical injury or illness.”
Punitive or exemplary damages that courts award to punish defendants’ egregious conduct are always taxable. Plaintiffs must report them as “other income” when filing taxes.
If your settlement includes interest on damages or attorneys’ fees, you must report this interest as taxable income.
How Settlement Method Affects Taxability
It does not matter whether you obtained your personal injury settlement via an out-of-court settlement agreement or a court verdict. The same federal tax laws outlined in IRC Section 104(a)(2) apply regardless of how you settled your case.
The method of settlement only matters when it comes to punitive damages and interest. These portions of compensation can only arise from court verdicts, not private negotiations.
Do I Owe Georgia State Taxes?
Under the federal tax code, personal injury settlements are taxed differently depending on the type of damages. Section 104(a)(2) of the Internal Revenue Code states that damages received for personal physical injuries or physical illness are not considered taxable income.
This means that any part of your settlement awarded for medical expenses, lost wages due to injury, pain, and suffering resulting from physical harm, or other damages stemming directly from a physical injury or illness are not subject to federal income tax.
However, Section 104(a)(2) does not exclude other types of damages from taxable income. For instance, compensation for emotional distress on its own, without related physical harm, would be considered taxable. Punitive damages awarded on top of compensatory damages are also always taxable.
If your settlement includes any taxable damages, you are required to report that portion of the settlement as “other income” on your federal tax return. The taxable amount will be subject to your ordinary federal income tax rate.
Strategies for Minimizing Taxes on Your Settlement
The best way to minimize taxes on your personal injury settlement is to maximize the amounts allocated toward physical injury and related losses. An experienced attorney can negotiate a favorable settlement breakdown with these tax implications in mind.
Other tips for reducing taxes owed include:
- Using structured settlements rather than lump sums when possible to spread out tax liabilities
- Making tax-deductible contributions to retirement accounts to lower your taxable income
- Avoiding settlement payment in a year you have abnormally high income from other sources
- Claiming all eligible dependents to increase your tax deductions
- Itemizing medical expense deductions instead of taking the standard deduction
Consult a Personal Injury Lawyer Before Filing Your Taxes
The tax laws surrounding personal injury settlements can be complex. To ensure you do not overpay taxes on your compensation, consult an attorney before filing. A personal injury attorney can review your settlement breakdown, project your tax obligations, suggest strategies to reduce taxes owed, and answer any other questions you have.
The injury lawyers at Sawyer Injury Law in Atlanta can help plaintiffs in Georgia understand settlement taxation and maximize their take-home compensation. They offer free case evaluations to examine your settlement offer, forecast potential tax liabilities, and get you the optimal net recovery amount.
Contact their team today to reduce taxes and maximize the value of your personal injury case.