Congrats, You’ve Just Received a Personal Injury Settlement! So, What Comes After the Win?

Winning a sizable settlement in a personal injury lawsuit is a great thing! At last, you have the long-awaited funds needed to get back on your feet, deal with medical expenses, pay overdue bills, and make up for lost wages. To help position you in a place to best manage your newly received cash, we’re answering some frequently asked questions about how settlement funds and tax implications you might face. While we are not imparting any form of financial advice, we are presenting an expanse of information that you can do with as you choose.

You May Wish to Protect Your Privacy and Hire a Trustworthy Financial Advisor

 
There are many reasons that may help explain why 70 percent of major lottery winners ultimately declare bankruptcy while many others are murdered, commit suicide, or become crime victims. You may unwittingly take on risk by letting other people know you’ve received a large financial windfall. Scam artists, thieves, and even relatives can all come out of the woodwork seeking shares of your kindness and generosity. While it is your prerogative to do whatever — and tell whomever —about your settlement funds, you may find it more desirable to be discreet with your good fortune.

It may also be in your best interests to find a trustworthy financial advisor to guide you in protecting your assets and budgeting your spending. Certified financial planners and registered independent advisors are professionals with the knowledge and training to do just that. Many are also bound by fiduciary standards which make them legally and ethically required to act only in the best interests of their clients. If they fail to do so, they can be held legally liable, which helps ensure investors that they won’t be scammed or otherwise victimized. To determine if your investment advisor is qualified as a fiduciary, you can easily check the U.S. Securities and Exchange Commission’s online database. Michigan’s Department of Insurance and Financial services also offers some helpful advice on choosing the right financial advisor close to home.

What Are the Tax Implications of a Legal Settlement and Giving Away Money?

 
While some generous states waive taxes on lottery winnings, Michigan isn’t one of them. In fact, lottery winnings are taxed as regular income in the Great Lakes State. The good news is that, as we explained in another recent article, personal injury lawsuit settlements are generally not taxed in Michigan. Federal taxes are another matter since punitive damages will usually fall into the taxable income category when filing your 1040. The important thing to know here is that you can always consult with a tax advisor to be sure you’re on the right side of Internal Revenue Service (IRS) regulations and don’t inadvertently put yourself at financial risk.

Another thing you can consider is a situation in which a friend or relative comes to you requesting monetary assistance. Federal tax laws permit you to give up to $17,000 (for tax year 2023) to individuals, or $34,000 to a married couple, without having to report it or to pay gift taxes. If you exceed those limits, however, you’ll need to file a federal gift tax return and you (not the recipient) will be required to pay federal withholding that can add between 18-40 percent of the sum you gave away, depending upon the amount of the gift and other factors. So, for example, the $50,000 down payment check you happily wrote to assist a relative’s down payment on a house could end up costing you significantly more than that amount. Again, the decision is yours and yours alone.

What About Those Federal Taxes on My Settlement?

 
As we mentioned, you won’t necessarily escape all taxes when you receive a settlement from your personal injury lawsuit. In most cases, the IRS separates personal injury settlements into two categories: (1) non-taxable, compensatory damages and (2) taxable, punitive damages. However, in almost every case, Michigan does not allow for punitive damages. Instead, it has exemplary damages. However, in most cases, the IRS will treat punitive and exemplary damages similarly for tax reasons. For the sake of this article, we will refer to both punitive and exemplary damages as punitive damages (because that is how the IRS will likely treat them).

Compensatory funds are intended to compensate victims for their pain and suffering, and to repay them for actual damages they’ve suffered (such as lost wages, medical bills, and rehabilitation costs). As such, compensatory damages are generally not taxable under current law. Punitive damages, on the other hand, are intended to punish the defendant for especially bad actions, malicious behavior, or extreme negligence that caused the plaintiff to be injured. These payments can go far beyond merely reimbursing you for costs you’ve absorbed. As a result, the IRS has determined that, while most compensatory settlements paid to injured parties are not taxable, punitive damages are almost always taxable as income to the recipients.

There’s just one exception to prove the rule, which concerns wrongful death lawsuits. In that instance, the IRS spells out its position as follows:

“Punitive damages are not excludable from gross income, with one exception. The exception applies to damages awarded for wrongful death, where under state law, the state statute provides only for punitive damages in wrongful death claims. In these cases, refer to IRC Section 104(c) which allows the exclusion of punitive damages. Burford v. United States, 642 F. Supp. 635 (N.D. Ala. 1986).”

What’s a Structured Settlement Compared to a Cash Payout?

 
Sometimes settlements come as a lump sum, a chunk of money you can simply put into a bank account and use as you wish (you can check into FDIC-insured high-yield savings accounts to safely get started and “park” your cash in a dependable place until you decide how to best invest it). In other situations, you’ll receive a structured settlement where money is put into an annuity and comes to you in smaller increments over an extended period of time. Sometimes you’ll get both an initial up-front lump sum along with a structured settlement that comes to you over the years to help you pay a lifetime of expenses.

In the event of a structured settlement, you may be approached by third-party companies that will offer to buy your settlement by giving you a cash payout that’s smaller than what you’d ultimately receive if you continued to receive the regular structured settlement payments. In many cases, you’ll be offered just a fraction of the total value of the structured settlement, which can cost you significantly in the long run. You may also need to go back to court and obtain a judge’s approval for your decision to sell your settlement. And as the Federal Trade Commission (FTC) notes, your structured settlement payments are generally tax-free, but taking a lump sum by cashing out a structured settlement could have tax implications by putting you into a higher tax bracket. This can all become very complicated so, if you choose to hire an investment advisor, you may find it beneficial to consult them to help you decide how to proceed.

We’re Here to Help You Win

 
Ultimately, we are here to help our clients pick up the pieces and rebuild their lives following an accident. And while there are infinite ways to spend or allocate settlement funds, that decision is fundamentally yours. Don’t hesitate to ask for our legal advice and counsel whenever you need it — we want you to live the best life possible following the final disposition of your case. As always, you can reach us at 855-MIKE-WINS (855-645-3946) or contact us online right here.

Content checked by Mike Morse, personal injury attorney with Mike Morse Injury Law Firm. Mike Morse is the founder of Mike Morse Law Firm, the largest personal injury law firm in Michigan. Since being founded in 1995, Mike Morse Law Firm has grown to over 200 employees, served 40,000 clients, and collected more than $1.5 billion for victims of auto, truck and motorcycle accidents. The main office is in Southfield, MI but you can also find us in Detroit, Sterling Heights and many other locations.