Can the IRS Take My Personal Injury Settlement?

  • August 17, 2021
  • Blog

If you have back taxes, yes—the IRS MIGHT take a portion of your personal injury settlement. If the IRS already has a lien on your personal property, it could potentially take your settlement as payment for your unpaid taxes behind that federal tax lien if you deposit the compensation into your bank account. Likewise, even if the IRS hasn’t filed a lien yet, it could levy taxes against certain portions of your personal injury settlement that aren’t intended to reimburse you for physical injuries or property losses. To the question, Can the IRS take my personal injury settlement, the answer is Yes.

A graphic of transparent circles with images of graphs, dollar signs, etc. and one larger main circular graphic with a white icon of a Greek temple that says IRS in the middle. In the bluish grey background is a photo of a business man and woman, with the man seeming to touch the circles in the foreground, posing the question, Can the IRS take my personal injury settlement.

Why Does the IRS File Tax Liens?

The IRS has all the power to file tax liens against taxpayers who don’t pay their federal taxes even after it has demanded payment from them. Tax liens will not automatically transfer property ownership to the IRS. However, it effectively establishes a claim, which could impact how the property might be used. For instance, if a lien extends to a person’s bank account, it could stop the account holder from using or withdrawing funds until the resolution of the lien. If you have tax liens against you, the answer to the question can the IRS take my personal injury settlement in Philadelphia is yes.

When working with a Philadelphia personal injury lawyer for your personal injury case, it’s critical that you inform your lawyer about potential tax issues or tax liens against you. This will help your lawyer figure out how those issues could affect your settlement and find ways to lessen the potential tax burdens.

The IRS Treats Personal Injury Settlements and Court Judgments Differently

In general, taxpayers receive compensation for a personal injury claim from out-of-court settlements or court judgments. If you're asking can the IRS take my personal injury settlement, this distinction is vital to income tax purposes.

Let’s say that a jury or judge has clearly allocated or awarded an injured victim’s damages through a court verdict. In this case, the IRS may not contest the nature of the compensation due to the objective and impartial nature of the court proceedings.

On the other hand, with personal injury settlements, which are settled out of the court system, people may have more flexibility to design the settlement payments in a more tax-friendly manner. This is why the IRS instructs its auditors to carefully review settlements to figure out whether the distributions and treatment are accurate and reflect the settlement’s exact economic substance.

Auditors evaluate various issues when they review tax audits that involve issues of personal injury settlements and verdicts. Put simply, the issues outlined in the auditing guidelines are specifically made to determine whether the personal injury compensation has been treated properly in accordance with federal tax laws. If you're wondering can the IRS take my personal injury settlement in regards to federal tax laws, auditors consider the following:

  • Whether any settlement, award, or lawsuit compensation has been reported accurately.
  • Whether payments were distributed properly among non-taxable and taxable amounts.
  • Whether punitive damages were awarded because punitive damages are taxed whether awarded for a non-physical or physical illness or injury.
  • Whether the amounts not counted as income were received because of a physical illness or injury. Emotional distress damages due to physical illness or injury are excludable. But expenses incurred for treating emotional distress will be taxed if they have been deducted previously as a medical expense in the past year.
  • Whether the person being audited reported the received payments as gross or net, including legal and related fees
  • Whether a part of the compensation could be considered interest, which counts as ordinary income.

Federal Tax Liens May Impact the Calculation of Personal Injury Settlements

The IRS places tax liens on taxpayers who failed to file their income tax returns. It will estimate how much the taxpayer earned and then calculate taxes owed. An injured victim’s personal injury settlement almost always includes compensation for wages or salary that the individual didn’t receive because they couldn’t go to work due to their injuries. 

If the injured victim doesn’t have salary records or pay stubs to substantiate their lost wages, their lawyer will turn to the individual’s tax returns to prove those wages. If this is the case, a federal tax lien might not impact the calculation of the settlement. However, if there are no tax returns, the tax lien might make the negotiations for lost wages compensation more complicated.

Can the IRS Take My Personal Injury Settlement?
Talk to an Experienced Philadelphia Personal Injury Lawyer

Are you wondering, Can the IRS take my personal injury settlement in Philadelphia? A skilled personal injury lawyer will know how to navigate tax issues related to personal injury settlements. However, it’s also best that you consult a tax professional or an accountant to help ensure that your personal circumstances will not get in the way when negotiating your settlement. Likewise, keep in mind that there are different rules on family issues, especially with child support and spousal support matters.

This means that just because the IRS cannot garnish your personal injury settlement unless for unpaid taxes, this does not mean that other federal and state authorities also cannot. Contact Mattiacci Law, LLC, to speak to a knowledgeable Philadelphia personal injury lawyer about your specific case. Schedule a free review of your case by calling 215-709-7915 or contacting us online.

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