What is not taxable: compensatory damages
Compensatory damages are intended to “recover” for losses directly related to your personal injury. You can view compensatory damages not as taxable income or “gains”, but as reimbursement.
A classic example of compensatory damages would be the reimbursement of past and future medical bills. Other economic losses, such as lost wages, earning potential, long-term personal care needs, and costs to change your living environment are also considered compensatory damages and are tax-free as long as that they relate to your personal injury claim. (Lost wages would be taxable in cases other than personal injury, such as employment discrimination or defamation, but this is generally not the case for personal injury.)
For this reason, compensatory damages awarded in personal injury settlements are not imposed by either the federal government or the state of Georgia.
Again, the logic here is that, if you have to pay $ 300,000 in medical bills and other direct costs (for example), it wouldn’t be fair to have to pay taxes on the $ 300,000 you receive as compensation. This $ 300,000 is not a “gain” for you, and taxing it would leave you with less than the total amount you need to cover these expenses.
What about pain and suffering (and other uneconomic compensatory damage)?
You might ask: what about things like pain and suffering, emotional distress, mental anguish, reduced quality of life, or other types of personal loss that don’t come at a cost? obvious ?
The good news is that any type of compensatory damage, including non-economic damage, is not taxable if it results from a physical injury or a physical illness. In a personal injury case this will be true most of the time.
Mental anguish, emotional distress, or other non-economic damage unrelated to injury or physical condition would be taxed. But this scenario generally only applies to other types of civil cases unrelated to personal injury, such as employment discrimination or breach of contract.
Exception to the rule: previous tax deductions
Things can get complicated when you’ve already deducted medical expenses out of pocket on a previous tax return. This can happen if your injury happened within a year, but you don’t receive your settlement or jury verdict until a year later.
For example, let’s say you were injured in 2020 and paid $ 50,000 in medical bills out of pocket. When you filed your tax returns for 2020, you took an itemized deduction for these costs, which reduced your taxable income for that year.
If you then win a personal injury settlement or trial verdict in 2021 or later, you will have to pay taxes on the $ 50,000 in compensatory damages awarded to you.