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When you receive a payment for a personal injury claim in Colorado, the intention is for the money to compensate you for losses you have sustained. As such, neither the IRS nor Colorado’s tax laws consider a personal injury settlement as income, so it will not generally be taxed. However, depending on the specific nature of your award, some aspects of it might be subject to taxation.
The legal team at The Wilhite Law Firm has compiled this helpful guide to help you understand what you need to know about personal injury cases and federal and state tax law. Working with a knowledgeable Colorado personal injury attorney can allow you to get answers to specific questions you might have about your case.
What Parts of a Personal Injury Settlement Are Not Taxable?
The purpose of a personal injury settlement in Colorado is to make an injured victim whole. In other words, the money they receive through the claims process is to compensate them for losses they sustained due to their injuries. Because these settlements merely restore personal injury victims to the level of wealth they would have enjoyed had the accident never occurred, federal and state tax laws do not consider personal injury compensation to be taxable income.
For this reason, the following parts of a personal injury settlement are not taxable:
- Medical expenses – Compensation for the costs of medical care is not taxable because you would never have incurred these losses if not for the at-fault party’s negligence.
- Lost income – Your personal injury settlement compensates you for your lost wages if the accident had never occurred. If not for the accident, you would have earned this money. To make you whole after the accident, your compensation includes wages. This money is not taxable at the federal or state level.
- Property damage – As with medical expenses, property damage compensation cannot be taxed because it does not add to your wealth. Instead, it restores you to your financial status before the accident.
- Pain and suffering – While pain and suffering damages compensate you for non-economic losses, Colorado tort law does not view this compensation as income. It intends to make up for what you lost due to the accident.
Are There Some Parts of a Personal Injury Settlement That May Be Taxable?
In some cases, certain aspects of a personal injury award might be subject to taxation, including:
- Punitive damages – If the at-fault party’s actions were extreme and intentional, Colorado may require them to pay punitive damages. This part of the award is considered taxable income because these damages are intended to punish the wrongdoer rather than compensate the victim.
- Prior medical deductions – If you paid some of your injury-related medical bills out-of-pocket in a previous tax year, you must claim that portion of your personal injury settlement as income. This might occur if your case spans more than one tax year.
- Interest on a jury award – In some cases, it may take some time for the at-fault party or their insurer to pay you. Your compensation will begin to accrue interest in the meantime. In such a scenario, you will be taxed on any interest you earn.
Could the IRS Take Some of My Injury Settlement If I Owe Back Taxes?
If you have outstanding tax debts or other obligations to the IRS when you receive your personal injury settlement, they may try to take a portion of your award. The IRS may take money from your settlement once it’s in your bank account. They cannot garnish your settlement, but once the money is in your bank, the IRS can take it if they have a lien against you.
However, working with an experienced attorney can help protect your settlement from IRS collection efforts. Your attorney may also be able to work out alternative payment plans or settlements with the IRS to resolve your tax debts without affecting your compensation.
Should I Seek the Help of a Tax Professional If I Have Received a Settlement?
Receiving a sizable personal injury settlement can create confusion about your tax obligations. To avoid any issues with the IRS, it is wise to consult with a tax professional or attorney regarding your specific case. A knowledgeable tax expert can help you determine which parts of your settlement may be taxable and which are not. They can also assist you with properly reporting any taxable portions of your award to avoid problems down the road.
Having expert tax guidance provides peace of mind that you are meeting all IRS requirements. This allows you to focus on your recovery without worrying about tax issues. Your Colorado personal injury attorney can recommend financial professionals who can help you.
Contact a Colorado Personal Injury Lawyer
If you have suffered injuries due to another person’s negligence, do not allow confusion or concerns about the IRS or taxes to keep you from pursuing your Colorado personal injury settlement. Working with a skilled attorney can help you understand what you need to know as you seek maximum compensation for your losses.
The dedicated Colorado personal injury attorneys at The Wilhite Law Firm understand how challenging and confusing life can feel after an injury. Let us use our many decades of combined legal experience to help you demand the compensation you deserve. Call us now or contact us online for a free case review to learn more about how we can help you.
