Personal injury settlements provide immense relief for victims of severe accidents and injuries.
However, many injured individuals wonder whether they might immediately lose a substantial amount of their settlement or jury award to the IRS.
Are personal injury settlements taxable in Wisconsin? You can rest assured that, for the most part, they are not. However, there is some nuance that you should be aware of.
At LawtonCates, our attorneys are fully versed in the tax laws that apply to personal injury settlements. We know what steps to take to fight for what you are owed and make sure you keep every penny you deserve.
Contact our Wisconsin personal injury attorneys today for a free consultation.
The General Rule Under Federal and Wisconsin Tax Law
In general, neither the IRS nor Wisconsin tax law treats compensation for physical injury as taxable income.
This is because personal injury settlements and verdicts are designed to make victims whole. In other words, the money you receive through a personal injury claim restores you to where you were or would have been if the accident had never occurred.
As such, the compensation cannot be treated as a net gain.
While this might be obvious for losses such as medical expenses and lost wages, the principle actually applies to any compensation you are awarded for non-economic losses such as pain and suffering as well.
In essence, all the victim’s losses that are tied to the injury fall under the same legal exclusion under 26 U.S.C. § 104(a)(2).
How the Wisconsin Department of Revenue Aligns With Federal Rules
While the federal tax system is famously complex, many people find that the tax rules at the state level are just as confusing.
As such, you might be wondering whether the Wisconsin Department of Revenue has any valid claims to your personal injury award, even if the IRS does not.
You’ll be relieved to learn that Wisconsin does not run a separate, stricter rule of its own. Under Wis. Stat. § 71.05, the state’s individual income tax takes the federal income you declare as its starting place – and there are no laws that make exceptions for the IRS’s personal injury award exclusions.
That means that if it is tax-free at the federal level, it remains tax-free on your Wisconsin return.
Which Parts of a Settlement Are Not Taxable?
For the purposes of clarity, here are the elements of your personal injury settlement that are protected from taxation under both federal and state law:
- Medical expenses – This category includes payments for medical bills, emergency services, doctor’s visits, various forms of medical treatment, and any future care that might be necessary due to serious injuries related to your accident.
- Pain and suffering – Any compensation you receive for physical discomfort connected to the injury has the same tax status as the underlying physical injury claim.
- Emotional distress linked to the injury – Even though money cannot fully make up for this kind of loss, an award for psychological distress or anguish stemming from your physical injuries is intended to be part and parcel of the “make whole” principle.
- Lost wages tied to the injury – As per Revenue Ruling 85-97, wage loss that is compensated as part of a physical injury settlement is excludable from taxation (unlike wages in an employment dispute).
- Property damage up to your basis – Payments for damaged property are not considered income, as long as the amount does not exceed what you originally invested in that property.
Which Parts of a Settlement Can Be Taxed?
In some cases, there are portions of a personal injury settlement that can be taxed. These include:
- Punitive damages – This type of award is designed to punish the at-fault party rather than to make you whole. As such, the IRS reserves the right to tax these damages, even inside an otherwise tax-free settlement.
- Interest on the settlement – If your settlement accrues interest while your case is pending, that interest is taxable as ordinary interest income.
- Previously deducted medical expenses – If you have already claimed a tax deduction for your injury-related medical expenses in a previous tax year, that portion of your award will then be taxable when it is reimbursed.
- Emotional distress not linked to a physical injury – If you receive an award for distress that doesn’t originate from a physical injury or illness, this will count as taxable settlement compensation. (Note that this is separate from the injury-related stress listed in the above section.)
Why the Wording of Your Settlement Agreement Matters
A clearly worded settlement agreement is one of the most important safeguards against unnecessary taxation.
This is because the IRS bases its tax determination on how the agreement categorizes the money. For this reason, a poorly worded agreement can turn a technically clean settlement into a tax headache.
How LawtonCates Protects Your Settlement From Unnecessary Taxes
If you are seeking compensation for a personal injury, one of the most important steps you can take to avoid a surprising tax bill is to hire a personal injury lawyer in Wisconsin with a thorough understanding of the applicable laws.
At LawtonCates, we are proactive about negotiating the precise language of each release and settlement so that it properly categorizes your compensation.
When necessary, we draft agreements that explicitly separate compensatory awards from punitive damages so that you are not taxed on the money that is making you whole.
Our personal injury law firm’s negotiation skills are also evident in our prior case results, including a $1.25 million settlement for a motorcycle accident victim and a $942,333.33 settlement for three injured individuals in a head-on collision, which we successfully resolved through an uninsured motorist claim.
Past results do not guarantee similar outcomes in the future, but they do stand as a testament to how hard we fight for our clients when negotiating settlements.
Do You Need to Report Your Settlement to the IRS?
If the whole of your settlement is not subject to taxation, then you generally do not have anything to report.
However, if part of it is taxable, the relevant amount will likely show up on a 1099, and you will report it as other income. For example, interest will be entered on Schedule B/Line 2b. Punitive damages and previously deducted medical expenses will be entered on Schedule 1, Line 8z.
Contact Our Wisconsin Personal Injury Lawyers for More Answers
You received personal injury compensation to restore you, as close as possible, to the state you were in before the injury occurred, and you deserve to keep what is rightfully yours.
If you have further questions or would like help seeking compensation for an injury you have sustained, contact LawtonCates today for a free consultation about your personal injury case.