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When are legal settlements taxed?

 

Dear Tax Talk,
I was involved in a motorcycle accident and now am expecting a pain-and-suffering settlement. Is the settlement taxable by the state or federal governments? -- Anon

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Dear Anon,
Amounts paid on account of physical injuries, dismemberment, disfigurement or accidental death are excluded from income. This is true whether the payment is made by way of a settlement or set by a court.

Amounts designated as punitive damages, however, are not excludable from income. Additionally, any amount that you receive for medical expenses that you may have previously deducted are not excluded from income.

Amounts relating to mental stress related to a physical injury are excludable from income. But amounts relating to mental stress from a personal injury unrelated to a physical injury are not excluded from income. For example, a settlement relating to slander, which is an injury to your reputation, is for personal injuries and is includable in income.

Compensatory damages for lost wages or income relating to your physical injury are also excludable from income.

Since most, if not all, states follow the same tax base as the Internal Revenue Service as far as what is considered income, you probably do not owe state income taxes either.

However, since each state has its own quirks, I would check with your state's taxation division.

 
-- Posted: Dec. 3, 2003
     

 

 
 

 

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