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Most, if not all, of the compensation you receive in a personal injury settlement isn’t taxable income. However, some of your settlement might be taxable. It’s crucial to be aware of the taxes that may apply to your hard-won compensation.
Non-Taxable Portions of a Settlement
According to IRS guidelines, the following portions of your settlement generally do not count as taxable income, either for federal purposes or in a Massachusetts personal injury case:
Compensation for Physical Injuries or Illness
Compensation for physical injuries or illnesses is generally not taxable at the federal or state level in Massachusetts. This includes money received for medical bills, pain and suffering, and emotional distress directly tied to a physical injury. The IRS considers this compensation a way to “make you whole” rather than income. However, if you previously deducted medical expenses related to the injury on your taxes and later received reimbursement through the settlement, the money for those expenses may be taxable.
Lost Wages
In personal injury cases, compensation for lost wages is typically not taxable because it is also intended to make you whole after an injury. The IRS treats this differently than lost wages in employment-related lawsuits, where taxes do apply. However, it’s crucial to clearly document that your lost wages stem from a physical injury and not an employment dispute. Proper classification helps ensure this portion of your settlement remains tax-free under federal and Massachusetts tax rules.
Taxable Portions of a Settlement
While most of the compensation you receive in a Massachusetts personal injury settlement isn’t taxable, these portions of your settlement, if you have them, are:
- Emotional Distress (Without Physical Injuries) – If your settlement includes compensation for emotional distress or mental anguish unrelated to a physical injury or illness, that portion is generally taxable. The IRS considers this compensation as income unless it directly relates to a physical injury.
- Punitive Damages – Punitive damages are always taxable, even if awarded in a case involving physical injuries. Unlike compensation meant to make you whole, punitive damages are intended to punish the at-fault party. The IRS requires you to report this amount as income, and you must include it on your tax return as “Other Income.” However, punitive damages are typically only included in court verdicts for certain types of cases.
- Interest on Settlements – If any portion of your settlement includes interest, that interest is considered taxable income. For example, if the settlement payout was delayed and accrued interest during that time, the IRS treats the interest as taxable interest income. You must report this amount as “Interest Income” on your tax return.
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Does Massachusetts Tax Personal Injury Settlements?
Massachusetts tax authorities follow IRS guidelines concerning taxes on personal injury settlements. You most likely won’t owe state taxes on your settlement. However, Massachusetts does tax punitive damages and interest on settlements, just like the IRS.
How Can You Protect Your Settlement from Taxes?
While most of your compensation in a settlement is not taxable income, there are strategies you can use to protect the taxable portion and decrease your potential tax liability. Those strategies include:
- Clarify Settlement Allocations – Ensure your settlement agreement clearly separates taxable and non-taxable portions, such as physical injury compensation, lost wages, and punitive damages. Properly defined allocations reduce confusion when preparing your tax return.
- Properly Deduct Medical Expenses – If you deducted medical expenses related to your injury in prior years, only the portion that provided a tax benefit becomes taxable. Accurately document past deductions to avoid overpaying in future years.
- Use Structured Settlements – Opt for a structured settlement instead of a lump sum. This spreads payments over time, helping reduce the immediate tax consequences on taxable portions.
- Document Your Emotional Distress – If your emotional distress stems from a physical injury, ensure it is clearly linked in the settlement. This can keep it tax-free under IRS guidelines.
- Consult a Tax Professional – A tax advisor can help you properly classify settlement amounts, identify deductions, and ensure compliance with IRS rules while minimizing your tax liability.
Do You Have Specific Questions? Contact Our Law Firm Today
Earley Law Group has helped countless Massachusetts residents recover and keep substantial compensation for their injuries. With over 20 years of legal experience and over 700 Google reviews from satisfied clients, you can trust Earley Law to guard your rights and support you throughout your case. One happy client says:
“Chris Earley and his associates were attentive and empathetic with my case. Chris and Erica always kept me informed throughout the process. They were never too busy to return a phone call. I truly felt I was in good hands. It was very easy dealing with Chris and Erica whom I felt had my best interests at all times. They were real advocates for me and were successful in obtaining a fair settlement. I have never met attorneys that were willing to go the extra mile to help a client. Kudos to all of you. I would recommend his services to anyone…”
What truly sets us apart is what we call The Earley Experience. We know that personal injury cases are about more than just compensation – they’re about trust, care, and delivering results when you need them most.
From the moment you call, we provide the white-glove treatment, treating you with the respect and attention you deserve. You’ll never be left in the dark, as we maintain frequent, honest communication and always respond within 24 hours. Our team works tirelessly to maximize your compensation, sparing no effort or expense to build the strongest case possible. And with our “no win, no fee” promise, you only pay if we succeed.
The Earley Experience is our commitment to you: top-notch service, clear communication, and relentless dedication to your success. If you’re not completely satisfied, we’ll make it right because your trust means everything to us.
Our Boston personal injury attorneys are ready to fight for you. Call Earley Law now or complete our contact form for a free consultation.
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