Receiving a cash settlement from a medical malpractice case can be a huge relief after what is usually a long and protracted process. But before you spend it, make sure you’re aware of any tax impacts it may have. The good news is that most of the payment will most likely not be taxable. A careful review of the breakdown of your settlement award will help clarify what’s taxable and what’s not.
What’s Not Taxable:
According to the IRS, payments for medical malpractice are classified as “personal physical injuries” settlements or compensatory damages. The portion of your award that compensates you or reimburses you for medical expenses and losses you suffered from the injury or sickness is non-taxable. The award may be for physical injuries as well as for emotional distress or mental anguish.
If a portion of the award is for emotional distress, there must be a clear connection between the emotional distress and the physical injury to be non-taxable. If the emotional distress or mental anguish did not result from the physical injury or sickness, that portion of the award will most likely be taxable.
What May Be Taxable:
Some portions of your settlement may be taxable income in the year you receive it.
Previously deducted medical expenses: If you deducted medical expenses for injuries involved in your medical malpractice case on your tax return, the amount you deducted may be taxable.
Punitive damages: Any portion of the award which is designed to punish the person or organization that caused harm will most likely be taxable to you.
Interest awarded: In some cases, the defendant may be required to pay you interest on the settlement amount from the date the medical malpractice suit was filed to the date of the settlement. This interest is likely to be taxable to you.
Lost wages or lost income: Any part of the award designated as compensation for lost wages or lost business income due to the injury or illness will be taxable. In addition, compensation for lost wages will also be subject to Social Security and Medicare taxes, while compensation for lost self-employment income will be subject to self-employment tax.
Review your settlement award carefully
Along with your award, you should receive documentation that breaks down the total settlement and how each portion is classified. Be sure to review this carefully and keep it with all your tax documents so you can share it with your tax professional when it’s time to file your tax return.