Most people who reach a personal injury settlement feel a sense of relief after the matter is over. After all, they are being compensated for the harm that someone has caused them. It sounds fair, right?
One part of personal injury settlements that people do not think about often is whether the money they receive is taxable. When this consideration comes to mind, a person who has just received compensation might worry about having to surrender a significant portion of what they received.
U.S. Federal laws’ perspective
Under federal law, you do not have to pay taxes on personal injury settlements. The reasoning behind this is simple: the government supports individuals dealing with the aftermath of an injury and does not want to add financial stress.
To be more specific, let’s look at the different compensation types to understand how the government treats each one.
Compensation for physical injuries
If your settlement is for physical injuries like a broken arm or any type of medical expense, it is usually not taxable. You need not worry about this when tax time rolls around. You may keep the money because of your physical injuries.
What about emotional distress?
Compensation for emotional distress is also non-taxable if it stems from a physical injury. This means that, just like compensation for physical injuries, you will not have to pay taxes on compensation for emotional distress that is connected to the physical injury.
Now we know how the federal government handles the taxing of personal injury settlements, but what about in Illinois?
Fortunately, the state follows the federal lead and personal injury settlements are typically not subject to state income tax in Illinois.
It is good that there is consistency between federal and state law in these matters because it makes it simpler for you—the injured individual—and it allows you to keep the compensation you are due.
Are there any exceptions?
As with everything, yes, there are exceptions. If part of the settlement involves punitive damages or interest, that part might be taxable. It is only that part, however, and the rest remains non-taxable.
Understanding the tax implications of a personal injury settlement is like having a roadmap. It is essential to be aware of the general rules. If you have specific questions about your case, it is critical to consult with someone who understands these cases and handles them all the time.
Remember that laws can be complex and can change, so having the latest and most accurate information is key to everything in the legal realm.