If you were just awarded a personal injury settlement, don't spend it all at once as your settlement may be taxed by the IRS depending on what type of award you were granted.
Lost Wage & Punitive Damage
If you were awarded any money for either lost wages or for punitive damages, both of these awards are considered taxable. Lost wages as well as punitive damage is taxed just like any other income you make would be; think of it as delayed income.
Emotional Distress & Mental Anguish
If part of your settlement was awarded to either compensate you for mental anguish or emotional distress, that portion of your settlement will be taxed. The IRS considers awards for mental anguish and emotional distress to be "other income" and you will need to declare it on your 1040 IRS form when you file your taxes.
However, there is a loop-hole to this rule. If you had to pay for any medical bills related to the mental anguish or emotional distress that you went through, those expenses can be subtracted from the portion of your settlement awarded for emotional distress and mental anguish. If this will be an ongoing expense for you, make sure that you talk with your tax professional about how to effectively write off your medical expenses in the future as well.
The one area of personal injury settlements where you do not face tax penalties is for compensation for physical injuries. The IRS considers awards for physical injuries as a way to pay back your past medical bills, future medical bills and compensate you for anything you will lose out on in life due to your physical injuries. Since this award is not related to income and related more towards compensation, you will not have to pay taxes on this portion of your award.
You are going to have to pay your attorney out of your settlement for their assistance with your case. However, the money that you pay your attorney is something that you can deduct from your taxes as well. Your attorney fees are considered a miscellaneous expense by the IRS. As long as your miscellaneous expenses reach at least 2% of your adjusted gross income, you should be able to deduct them. As most attorney's expect to be paid greater than 2% of your settlement, this should not be a difficult amount to reach.
Make sure that you look into the tax implications before you start spending any settlement you are awarded in a personal injury case; you don't want to find yourself in financial trouble because you failed to understand that you would have to pay taxes on your settlement. For more information, contact firms like Gartner Law Firm.