Despite what courtroom dramas on film and TV might suggest, the vast majority of personal injury cases settle long before ever going to trial. When you accept a settlement offer from the other party – or their insurance company – your case is effectively over.
However, because settlements are final, you should consider the details and implications of any settlement offers before you agree to them. This includes how state or federal tax law could affect the value of your settlement.
Our experienced Honolulu personal injury attorney at the Recovery Law Center understand that you want to collect what you’re owed and move on with your life after a severe injury accident. We’re here to help you understand the taxation of compensation awards and settlement payments in Hawaii – and how your claim could be affected.
If you’ve been hurt and need assistance from a knowledgeable injury lawyer in Honolulu, contact us today to learn more in a free consultation.
Can My Injury Settlement Be Taxed in Hawaii?
If you are considering an injury settlement offer or suing for compensation in Hawaii courts, you may be wondering whether the monetary award you could receive will be subject to state or federal taxes. In short, the answer depends on the nature of your accident, the losses and injuries you suffered, and the payment you ultimately accept.
Below, the legal team at the Recovery Law Center addresses some of the most common concerns and frequently asked questions our clients have about personal injury settlements and taxable income here in Hawaii.
What if I Received My Compensation from the Proceeds of a Trial Verdict?
According to Section 104 of the United States tax code, the compensation that injured victims receive from a personal injury claim is not subject to either state or federal income tax. It does not matter whether you receive compensation from a settlement agreement that is finalized before or after you file a lawsuit, or if your compensation comes from the proceeds of a trial verdict.
Neither the IRS nor the state of Hawaii can levy taxes on any financial awards you receive to compensate you for a physical injury or illness. The compensation you are awarded for your physical injury can also be excluded from your gross income when you file your annual tax return.
What If I Receive a Lump-Sum Payment For My Personal Injury Claim?
In the United States, individuals with higher incomes are sometimes subject to unique taxation requirements under the alternative minimum tax (AMT) system. If your annual income exceeds the exemption threshold for the AMT, you may need to calculate your taxable income using AMT rules rather than the standard tax system, which could mean that you’d owe more in taxes.
AMT rules tend to be much stricter than regular tax rules and do not allow for itemized deductions. This means that if you receive a single lump-sum payment for your personal injury settlement, you may not be able to separate the tax-exempt income you receive for things like physical injuries from the taxable income you receive for other losses.
Because of this distinction, many personal injury claimants choose to accept taxable compensation payments over several years through a structured settlement. This allows you to report less taxable income in any given year and avoid the implications of the AMT. A personal injury attorney can help you work out a settlement agreement that takes these factors into consideration.
What If I Invest the Money I Receive From My Settlement?
If you decide to invest any money you receive from your settlement, you should also be aware of the possible effects of the net investment income tax (NIT). You may be subject to NIT requirements if you earn a substantial amount of investment income and your adjusted gross income exceeds certain thresholds.
Even if you only make investments using non-taxable proceeds from your settlement, the money you earn from those investments is often taxable. However, it may be possible to avoid paying taxes on such proceeds if you agree to receive them over a longer period in a structured settlement.
How Can I Structure My Settlement Agreement to Reduce My Tax Burden?
The way that your settlement proceeds are taxed could depend on the intent of the party that paid you and the language of your settlement agreement. For example, if your settlement agreement does not explicitly refer to the fact that you are receiving compensation for a physical injury, the IRS may not be able to verify that the money should be tax-exempt.
To avoid unnecessary tax burdens, you should work with your attorney to ensure that your settlement agreement explicitly includes:
- The payor’s reason for paying you the settlement
- Which portions of the settlement payment are taxable or non-taxable
- A provision that prohibits the payor from issuing you a 1099-MISC form for income that should be non-taxable
What Can and Cannot Be Taxed After a Settlement?
In many cases, injury settlements include compensation for both physical injuries and non-physical effects suffered by accident victims, such as emotional distress or mental anguish. It’s important to consider how the types of compensation you are awarded could affect your overall tax burden since different types of compensation are taxed in different ways.
The law specifies that most settlement or verdict proceeds you receive from a personal injury claim are exempt from state or federal income tax. This is because most personal injury claims include compensation for physical injuries, which is non-taxable, according to the IRS. Any money you receive as direct compensation for the effects of a physical injury or illness will not be considered taxable income or included in your gross income for tax purposes. This includes compensation for things like medical expenses, lost wages, and attorneys’ fees.
However, if you receive payment for non-physical damages like emotional distress, psychological therapy expenses, or loss of quality of life, those kinds of compensation could be considered taxable if they were not directly related to your personal injuries. You would only be able to avoid paying taxes on compensation for non-physical issues if you structured your settlement agreement to specify that your emotional distress or other non-physical issue was a direct result of your physical injuries.
Finally, if you were injured in an accident in which the at-fault party was especially negligent, reckless, or intentionally malicious, you could be eligible to receive punitive damages. Compensation for punitive damages is awarded to punish defendants in cases of egregious negligence, and this kind of payment is always taxable. The best way to ensure you do not pay unnecessary taxes on payments you receive for punitive damages is to have your award separated into compensatory and punitive damages, so the IRS knows which portions of your income are non-taxable.
Do I Need to Report My Settlement to the IRS?
If the payment you received from your personal injury settlement was intended solely to compensate you for the effects of your physical injuries, the proceeds should not be considered taxable, and you should not have to report them to the IRS. However, if you received any punitive damage payments or compensation for non-physical injuries unrelated to physical injuries, those settlement proceeds could be considered taxable, and you may need to include them when you file your tax return.
Any taxable settlement payment you receive will be taxed according to your ordinary income tax rates, but larger payments or lump-sum settlements could very easily push you into a higher tax bracket. No matter what kind of settlement you consider or accept, it’s a good idea to consult with a knowledgeable attorney to make sure you understand the full tax implications of the agreement.
Contact a Honolulu Personal Injury Lawyer If You’ve Been Injured
If you’ve been injured because of a Honolulu car wreck, slip and fall accident, or pedestrian accident, contact our Honolulu personal injury lawyer at Recovery Law Center today. For more than 25 years, founding attorney Glenn Honda and his relentless team have worked hard to make life easier for our clients.
We understand the ins and outs of personal injury law in Hawaii, and we can explain how state and federal tax laws could affect the settlement you receive for your claim. We are proud of our history of five-star client reviews and confident in our ability to secure real results for you.
We represent clients on a contingency-fee-basis. This means you pay us nothing until we win, and your initial consultation is always free. We’re available to take your call 24/7. Contact us by filling out a contact form, calling our phone number, or by chatting with us live now.