“Is my medical malpractice settlement taxable?” This is a common question we get when our clients receive financial compensation from a lawsuit settlement.
Whether you need to include settlement funds on your state and federal taxes depends on the circumstances of your case. Generally, you are taxed on something if state and federal tax laws define it as income. However, some aspects of malpractice settlements are regarded as compensation due to loss, so it’s important to understand the difference.
At Janet, Janet & Suggs, our medical malpractice lawyers can help you get the settlement you deserve, and we’ll provide you with some general information about the tax considerations you will need to keep in mind after the fact.
Personal Physical Illness or Injury
The federal tax code provides a gross income exclusion for compensation related to physical illness or injury. If you didn’t previously total up your medical expenditures as an itemized deduction prior to the settlement of your lawsuit, then the entire amount you receive as compensation for medical expenses, lost wages and physical pain due to a medical mistake is non-taxable.
If you’ve already claimed medical expenditure deductions for treatment of illness or injuries related to the lawsuit, the rules for state and federal taxes are different. You would need to include the amount you already claimed for these expenses as income if they provided a tax benefit to you. If you’ve claimed medical expenditures for more than a single year, you need to note the tax benefits received for each of these years on a proportional basis. You will report this income on Form 1040-ES, Estimated Tax for Individuals.
Emotional Distress or Mental Anguish
Financial compensation recovered for emotional injuries or mental anguish stemming from physical illness or injuries you experienced due to malpractice also comes to you on a non-taxable basis. This is because this emotional distress is considered to be part of the physical injury.
If you are awarded financial compensation for emotional injuries that are not related to a physical illness or injury, you need to report that money as part of your taxable income, but this is unlikely to come up in medical malpractice cases (which generally result from physical injuries). The Internal Revenue Service (IRS) views symptoms such as insomnia, stomachaches, and headaches as normal physical reactions to emotional stress.
Punitive damages, also known as exemplary damages, are assessed during a jury verdict to punish the defendant for their negligent actions that caused harm to the plaintiff. Punitive damages are typically awarded for making an example of the defendant in hopes of deterring others from acting in the same way or committing similar behaviors. These damages are rare in medical malpractice cases, but they may be awarded if there is strong evidence of malice, fraud, or recklessness on the part of the defendant.
Funds awarded as punitive damages are considered taxable and need to be noted as “Other Income” on line 21 on Form 1040, Schedule 1. This is true even for the punitive damages that were part of a settlement for physical sickness or injuries.
You may need to make an estimated tax payment on your settlement if you anticipate your taxes to be over $1,000 after subtracting withholdings and credits. You can find information on estimated taxes in IRS Publication 505, Tax Withholding and Estimated Tax.
State Taxes and Malpractice Settlements
Your medical malpractice settlement will likely be subject to state taxes as well if you live in a state that collects income taxes. Which portions are considered taxable income and which ones aren’t can vary from state to state, so you will need to review your state’s tax code or consult with a tax professional who knows your local state requirements.
Important Note About Health Insurance Coverage
If you, a dependent or spouse enrolled in health insurance coverage via the Health Insurance Marketplace, made advance payments on the premium tax credit to the insurance company and have an increase in income due to a taxable settlement, you need to let the Marketplace know. Reporting this change enables the Marketplace to modify the amount of any advance credit payments you receive, which helps prevent significant differences between the premium tax credit you’re allowed and your advance credit payment. This can potentially increase your tax liability.
When you settle your lawsuit and obtain financial compensation for damages, you will likely be responsible for state and federal income taxes on some or all of the capital you receive. Specific kinds of payments are excluded from lawsuit settlement taxes, making the situation even more complicated. To determine if a particular payment is taxable or not, you need to consider the reason these funds were awarded and the claims made in previous tax years.If you have experienced medical malpractice and want to pursue a lawsuit, it’s crucial to work with a qualified medical malpractice law firm and tax professionals who are familiar with the specific state and federal tax laws. Complete this online form to let the legal team at Janet, Janet & Suggs evaluate your claim and schedule a free, no-obligation consultation today.