Taxes on Settlements

Under federal tax rules, damages received because of a physical injury or physical sickness are generally excluded from taxable income. For most mesothelioma claims, compensation for medical costs, pain and suffering, and lost wages tied to the illness may fall under this exclusion. Wrongful death recoveries are often treated similarly, though the details depend on how the recovery is structured and what it is meant to cover. Because the exclusion depends on the nature of each payment, the way a settlement is described in the written agreement can matter. Keep every settlement document, and have a tax professional review them before filing your return for the year you receive funds.

Not every dollar in a recovery is treated the same way. Punitive damages, which are meant to punish a company rather than compensate for harm, are generally taxable. Interest paid on a judgment or settlement is usually taxable as well. If you previously deducted medical expenses on a tax return and are later reimbursed for them, part of the recovery may need to be reported. Payments that replace income for reasons unrelated to the illness could also be treated differently. Your legal team can explain how each payment is labeled, and a tax advisor can explain what, if anything, needs to be reported.

Settlements and trust payments often arrive in stages over months, which can make tax planning more complicated than it first appears. Before money comes in, ask your attorneys for a written breakdown of what each payment covers. Share that information with a tax professional who understands personal injury recoveries. If you receive government benefits based on income or assets, such as Medicaid or Supplemental Security Income, a benefits or elder law advisor may also help. For estates, the executor may need to consider estate tax and income tax questions separately. Early planning gives you more choices and fewer surprises.

1. 1

   Ask your attorneys for a written allocation showing what each settlement payment covers.

2. 2

   Keep every settlement agreement, trust payment letter and closing statement together.

3. 3

   Schedule a meeting with a tax professional before the tax year in which funds arrive.

4. 4

   Tell the tax advisor if you ever deducted medical expenses that are now being reimbursed.