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Are Personal Injury Compensation Payments Taxable (in the USA)?

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Personal injury compensation payments are a concern for taxpayers when it comes time to file at years' end. The April 15 deadline brings fearful thoughts when one is considering the question, "are personal injury compensation payments taxable on my income statement for taxes?" The good news is they are not taxable, maybe parts of the payments are taxable, and in some rare cases, all of the income is taxable. Here is the breakdown of the most common elements for an individual that has received a settlement.

If you have received a settlement because of a physical sickness or injury, for example, a car accident injury , and did not previously claim the medical expenses on your taxes, the entire amount is not taxable. Do not claim this settlement as income. Mental anguish payments from a physical illness or injury are not taxable.

If your mental anguish or emotional distress payments are not originated from the physical injury or sickness, they are considered income. You can reduce the total amount by the amounts you have already paid in medical expenses (that have not been previously claimed). Attach a page to your return as "Other Income" and list the settlement, minus the related medical expenses. This is the amount to be recorded on line 21 of your Form 1040.

However, if you have already deducted part of the medical expenses you paid in past years on your Form 1040, you list the the pro rata amount in the "Other Income" line of the Form 1040. (This is line 21.) The IRS Publication number 525 gives the details on calculating pro rata for this process.

If you receive compensation in a lawsuit for lost wages due to discrimination, etc., the portion of the settlement that is claimed as "wages" must be treated as income. Taxes are required to be paid, in addition to Medicare and social security wages, for any back pay, severance pay, and wages owed.

All interest is taxable and reported under "interest income", line 8a on the IRS 1040.

Any punitive damages that are received in the settlement are taxable and are listed in the "Other Income" line 21 of the Form 1040.

More detailed information can be found in the IRS publication number 525, entitled, "Taxable and Nontaxable Income".

Some people that receive a settlement will have taxes totaling $1,000 or more. If this is the case, they might be required to file estimated tax payments. The IRS pamphlet "Tax Withholding and Estimated Tax", number 505, will be helpful in this situation. The form required to file this tax is the Form 1040-ES, known as the Estimated Tax for Individuals.

Your lawyer will help you untangle the specifics after you receive a settlement. With this guide, and consulting the IRS brochures, it is simple to determine which funds are taxable and which are not. Make sure you have a detailed list of the settlement proceeds, so that you will easily be able to match their taxable status. Aforethought goes a long way when deciphering where to claim income and what is not income with the Internal Revenue Service.