Are Insurance Settlements Taxable?

One financial factor that everyone must consider when creating a budget or planning for a financial future are taxes. Taxes are required to be paid by everyone, but not everything is taxable. One area that leaves a lot of people confused is insurance settlements. Many people get confused when trying to find out if insurance settlements are taxable or not. The answer is not so clear when it comes to finding out of insurance settlements are taxable. In fact, there are many different kinds of insurance settlements, some may be taxable while others or not. In other words, some insurance settlements may be taxable depending on the nature of the settlement.

First off, there are basically three main types of insurance settlements like personal injury settlements, properly damage settlements and punitive damage settlements. Insurance settlements that deal with personal injuries are considered not taxable. The reason why personal insurance settlements are not taxable is because the money received from the settlement is viewed as getting the plaintiff back to where they were previously. The money received from the settlement is not considered income. People who are injured from an accident at work or while driving will put forth a lawsuit in order to receive compensation.

Compensation isn’t exactly an income because it’s considered a means of catching back up with where the plaintiff was before their injuries. During a time of injuries, the plaintiff may lose income, which will need to be reimbursed if the plaintiff wins their case. Property damage insurance settlements will also not be taxable for basically the same reasons. For example, property that is damaged means the plaintiff loses value on their assets. Instead of the money received being viewed as income, it is viewed as reimbursement for what was lost from property damage.

Last but not least is a punitive damage insurance settlement. Punitive damages are viewed totally different than personal injury and property damage insurance settlements. Both property damage and injury insurance settlements are considered reimbursement. On the other hand, punitive damages are considered income because the money received from an insurance settlement involving punitive damages goes well beyond reimbursement. Nothing is being reimbursed in punitive damages because nothing can be proven to be lost. Moreover, punitive damages are indeed taxable. Settlements involving all three types of damages and injuries will be divided in two three sums of payments when the plaintiff wins their settlement case.

The reason why these three areas of settlements are divided into their appropriate categories is for tax purposes. While personal injury and property damages are not taxable, punitive damages are, which is why these are separated. Punitive damages are basically emotional stress or other mental conditions that a plaintiff may be experiencing because of the loss of income, property damage or bodily injury. Regardless of punitive damages being taxable, a plaintiff will receive the necessary funds for their bodily injuries and property damage, whichever may be the case. Everyone should understand how the IRS views insurance settlements, especially when involved in a settlement case.

Insurance settlement cases will require the plaintiff to pay their legal fees and lawyers in order to move the case forward. Many lawsuits involve the plaintiff suing for legal fees along with other financial losses that typically occur during an insurance settlement case. Plaintiffs should never try to skip out on not paying their taxes, especially when receiving cash for punitive damages. Paying taxes on money received for punitive damages is a small price to pay. The plaintiff will still receive cash for punitive damages if they win their case. The only downside to punitive damages is the fact that a certain percentage must be paid to the IRS.

What Do You Think?