Do You Have to Pay Taxes on a Personal Injury Settlement in Alabama?
When you are injured and receive a big personal injury settlement check, the question of taxes arises. After all, almost every source of income is taxable these days. But do you have to pay taxes on a personal injury settlement?
The answer may surprise you. In most instances, you will not have to pay taxes on money received in a personal injury settlement in Alabama. However, there are a few exceptions.
If you are making a personal injury claim in Alabama, read this blog post to understand the tax ramifications of a personal injury settlement.
Federal Taxes on Personal Injury Settlements
Internal Revenue Code Section 104(a)(2) states:
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include…the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness…
This is great news for injured people, but how could this be?
Our federal tax code treats personal injury money not as a “financial gain.” Rather, our laws consider personal injury income as simply being reimbursed for something that was lost. Therefore, if you’ve been injured and receive compensation, it is likely that none of your personal injury settlement will be taxed at the federal level. Money received “on account of personal physical injuries” is not considered “income.”
However, there is one exception — punitive damages.
But what are “punitive damages”?
The Punitive Damages Exception
Punitive damages are money awarded to an injured person when the at-fault party acted recklessly or intentionally. These damages can be awarded by a judge or jury at trial to punish the wrongdoer. Punitive damages are different from compensatory damages because their purpose is not to compensate the injured person.
If punitive damages are awarded to an injured person, then the amount of punitive damages is taxable. The portion of your settlement or verdict attributed to punitive damages will be taxed at your applicable income tax rate.
The “Physical” Injury Requirement
There is another phrase of Section 104(a)(2) we need to look at. The last phrase of the code section states that the settlement is not taxable only if the money is due to personal “physical” injuries. If your personal injury claim is based solely on emotional injuries, then it is likely the settlement money is taxable. There must be a physical injury involved in order for the money to be non-taxable.
Therefore, if the following two statements are true, then your personal injury settlement money is not taxable:
- The settlement is for compensatory damages; and
- The settlement results from a physical injury to your body
If you are unsure as to whether your settlement is for compensatory damages, read our blog post about Compensatory Damages.
Most personal injury claims include only compensatory damages, such as cases involving car accidents, slip and fall incidents, and medical malpractice claims.
State Taxes on Personal Injury Settlements
Different states have different tax rules on personal injury settlement money. In our home state of Alabama, our rules mirror the federal IRC Section 104(a)(2). Therefore, in Alabama, if your settlement is not taxed at the federal level, it will not be taxed by the state of Alabama.
If you receive a personal injury settlement in another state, you should check with an accountant about your state’s tax rules about personal injury settlements.
We represent people in Alabama in all types of personal injury claims. While we are not accountants, we have answered these tax questions many times while representing our clients. If we can ever be of assistance, reach out to us today.