The majority of personal injury cases settle before they reach the courts. Some go to trial and usually result in a jury verdict that favors the injured plaintiff. But whether your case was settled out or in court, you may need to pay taxes on the settlement that you receive. Consulting a reputed Hawaii tax planning attorney is recommended before you make any financial decisions regarding your settlement to avoid surprises later on. In the meantime, find out if and when your personal injury settlement is taxable.
General Tax Rules on Personal Injury Settlements in Hawaii
According to the IRS’ settlements taxability rules, anyone who receives compensation for physical injuries and didn’t list it as an itemized deduction for medical costs associated with illness or injury in previous years won’t be taxed on that portion of the personal injury settlement. If this is the case for you, you also shouldn’t include the compensation in your taxable income.
Remember that the IRS can easily access the details of your settlement. In most cases, the insurance provider reports to the IRS the exact compensation amount you received when your claim was settled. The settlement check and release form typically don’t indicate the breakdown of damages included in the injury settlement.
Insurance providers normally pay out compensation in one lump sum, and it’s up to the recipient to allocate the amounts. More importantly, it’s your job to properly disclose any taxable portions of your settlements and pay relevant taxes on them. Otherwise, you will be subjected to penalties under the IRS tax laws.
Medical Expenses May Also Be Taxable in Hawaii
The IRS will only tax settlements for medical bills if you utilized qualified medical expenses for an itemized tax deduction on your tax return last year. Qualified medical expenses include medical expenses for diagnosing, treating, curing, preventing or mitigating a disease or affecting any body function or structure. Put simply, if you utilized the costs for treating your injuries to count as medical tax deductions on your tax return last year, this portion of your settlement must be treated as income and is, therefore, taxable. This also applies to joint filings.
Wages and Income Is Taxable in Hawaii
Your personal injury settlement might include compensation to cover your lost income or wages if you need to take time off work to treat and recover from your injuries. This is still considered income under tax rules, so you will need to disclose it when you file your yearly income taxes. Basically, the IRS expects you to pay taxes on that income, regardless of who paid that income. But, you should also be aware that other kinds of settlement compensation would be considered ordinary income by the IRS for tax purposes. These can include:
- Emotional distress
- Punitive damages
- Lawyer fees if the gross income included the underlying recovery
- Non-injury claim awards
- Any interest on the settlement amount
It’s important to remember that while punitive damages can be taxed, not all personal injury settlements include them. These damages are usually awarded for punishing wrongdoers in high-dollar personal injury cases, such as defective products, medical malpractice, etc.
Hawaii Personal Injury Lawyer Fees May Be Taxable
If you work with your Hawaii personal injury attorney on a contingency basis, you’ll be taxed on the entire amount of recovered money. Basically, you need to pay taxes on the part of your compensation that is allotted to your attorneys as their professional fee. This will still apply if the defendant paid the lawyer fees. Ultimately, in physical injury claims where the entire compensation amount isn’t taxable, you won’t have any issues. But, if it is, having sound tax advice as early as possible is crucial.
A Vital Note on Hawaii Emotional Distress Taxes
Tax authorities differentiate between emotional distress awards that aren’t related to physical injury and pain and suffering compensation related to physical injury. The reason for this is that physical injuries are diagnosable in medical terms, while emotional distress for the same injury can’t. Nonetheless, emotional suffering is very real, and the emotional and physical are two components of the entire loss, meaning that they are not taxable.
However, emotional distress awards may be taxed when they’re not linked directly to the physical injury. Emotional distress symptoms like vomiting or headaches are not considered physical injuries, though compensation for medical expenses considers the same symptoms non-taxable. Besides emotional distress, compensation for something other than physical injuries, like injury to character or unlawful discrimination, will be taxed.
Seek Legal Advice from an Experienced Hawaii Tax Planning Attorney Today
The taxation of personal injury awards and settlements is nuanced and significantly depends on the specific circumstances and facts of every case. There many opportunities via proper and early tax planning to mitigate the potential tax consequences. A skilled Hawaii tax planning attorney can help guide you through the details.
Reach out to us here at Olson & Sons to arrange a consultation with one of our tax planning lawyers by calling our Kona office at 808-427-1025 or our Kamuela office at 808-201-1679. You can also filling out our online form for more information and to have someone contact you about your potential personal injury case.