Suffering an injury can feel like being caught in a storm—confusing, overwhelming, and uncertain. When an injured person seeks a personal injury lawsuit settlement, they face a legal system influenced by both federal and state laws. These laws shape settlement amounts, tax obligations, and legal rights, making it crucial to understand how federal and state laws impact injury settlements and compensation.
Federal regulations, such as tax laws, often overlap with state statutes governing personal injury claims, creating unique challenges. To help you navigate these complexities, we have outlined key differences, tax implications, and legal considerations so you can protect your rights and maximize your settlement.
Federal and State Roles in Personal Injury Settlements
Federal law primarily affects taxation, healthcare reimbursement, and benefits programs. State law, on the other hand, governs claim details, including deadlines, damage caps, and negligence rules.
Federal Laws Impacting Injury Settlements
Internal Revenue Code (IRC) Section 104(a)(2): Compensation for physical injuries or illness is tax-free, but punitive damages and emotional distress without physical harm are taxable.
Social Security Disability Insurance (SSDI) & Supplemental Security Income (SSI): Large settlements can impact eligibility for SSI due to asset limitations. (SSA)
Employee Retirement Income Security Act (ERISA): May require injured parties to reimburse their employer-sponsored health insurance from settlement proceeds.
Medicare Secondary Payer Act: Requires repayment to Medicare from settlement funds if Medicare initially covered injury-related expenses. (Medicare Secondary Payer | CMS)
State-Specific Personal Injury Laws
Each state has unique rules affecting injury claims:
Below are the laws governing personal injury claims in California, Colorado, and Nevada:
Nevada:
General Rule: Punitive damages may be awarded when clear and convincing evidence proves that the defendant acted with oppression, fraud, or malice in a non-contractual dispute.
Caps on Punitive Damages: Three times the amount of compensatory damages if the award is $100,000 or more.
Exceptions (No Cap Applies):
The limits do not apply in cases involving:
Defective products (against manufacturers, distributors, or sellers).
Insurance bad faith (when an insurer unfairly denies or delays coverage).
Discriminatory housing practices (if federal or state law allows higher punitive damages).
Toxic or hazardous material exposure (causing injury or harm).
Defamation (cases involving reputational harm).
Determination of Punitive Damages:
The jury or judge must first decide if punitive damages should be awarded.
A separate proceeding then determines the amount of punitive damages.
The jury cannot be told about the statutory limits during deliberations.
Defendant’s Financial Condition: Evidence of the defendant’s financial status is inadmissible during the main trial. It can only be introduced after punitive damages are approved.
California
General Rule: California does not cap compensatory damages for most personal injury cases. However, medical malpractice cases have statutory limits on non-economic damages (such as pain and suffering).
New Caps as of January 1, 2023 (AB 35 Amendment to Civil Code § 3333.2):
Personal injury cases (not involving wrongful death):
$350,000 cap on non-economic damages against health care providers or health care institutions.
This cap increases annually by $40,000 until it reaches $750,000 by 2033.
Wrongful death cases:
$500,000 cap on non-economic damages.
This cap increases annually by $50,000 until it reaches $1,000,000 by 2033.
Important Considerations:
The cap applies per defendant category (health care provider vs. institution).
Economic damages (e.g., medical expenses and lost wages) have no cap.
The dollar amount in effect at the time of judgment or settlement applies.
Starting January 1, 2034, the cap will be adjusted for inflation by 2% annually.
These state-specific regulations can influence how much an injured party ultimately receives.
Colorado
Statute of Limitations
Colorado law requires plaintiffs to file personal injury claims within two years from the date of injury.
If the injury results from a motor vehicle accident, plaintiffs must file within three years.
Wrongful death claims must be filed within two years, except when the defendant committed vehicular homicide and fled, which extends the limit to four years.
Failure to meet the deadline results in case dismissal.
(C.R.S. § 13-80-102, C.R.S. § 13-80-101)
Comparative Negligence Rule
Colorado follows a modified comparative negligence system.
Plaintiffs can recover damages only if their fault does not exceed 49%.
Courts reduce compensation based on the plaintiff’s percentage of fault.
(C.R.S. § 13-21-111.5)
Caps on Non-Economic Damages
Colorado limits non-economic damages in personal injury cases to $250,000, adjusted for inflation.
Courts may increase the cap to $500,000 if clear evidence justifies it.
(C.R.S. § 13-21-102.5)
Punitive Damages Restrictions
Plaintiffs must prove the defendant acted with fraud, malice, or willful misconduct.
Courts cannot award punitive damages higher than actual damages unless clear evidence justifies an increase.
(C.R.S. § 13-21-102)
Federal Preemption and State Law: Key Cases
O’Gilvie v. United States (1996)
Federal Statute: Internal Revenue Code (IRC) Section 104(a)(2)
Issue: Whether punitive damages awarded under state tort law for personal injuries are subject to federal income tax.
Decision: The Supreme Court rules punitive damages from personal injury claims are taxable. The Court emphasizes punitive damages serve as punishment, not direct compensation.
Impact: Plaintiffs must factor in federal tax obligations when evaluating settlements, influencing the net compensation received under state law.
Riegel v. Medtronic, Inc. (2008)
Federal Statute: Medical Device Amendments of 1976 (MDA), Food, Drug, and Cosmetic Act
Issue: Whether FDA approval preempts state tort claims involving the safety of medical devices.
Decision: The Supreme Court rules FDA premarket approval preempts state-law claims challenging device safety or effectiveness.
Impact: Injured patients cannot bring state tort claims against manufacturers of FDA-approved medical devices for defective design or labeling. The ruling significantly restricts plaintiffs’ ability to seek compensation under state law, underscoring the dominance of federal regulation in certain areas.
Understanding the Tax Implications of Personal Injury and Wrongful Death Settlements
Which Portions of a Settlement Are Taxable?
The Internal Revenue Service (IRS) categorizes different portions of a personal injury case settlement based on whether they are taxable or non-taxable:
Tax-Free Compensation:
Medical expenses related to a physical injury or sickness
Lost wages if included in a workers’ compensation claim
Compensatory damages for physical harm
Typically Taxable Compensation:
Punitive damages
Emotional distress without physical injury
Interest income on settlement funds
Severance pay when tied to an employment-related injury
How Much Tax Do You Owe?
Taxes on settlement amounts depend on specific circumstances, such as whether the settlement was received as a lump sum payment or through periodic payments. A tax professional can help injured parties determine potential tax implications and whether they need to pay taxes on their settlements.
Legal Fees and Their Tax Consequences
Many injury victims hire a personal injury attorney to handle their cases. However, legal fees can impact the taxable income from a settlement. Under federal tax laws:
If a lawsuit results in a non-taxable settlement, legal fees are not considered taxable.
If portions of the settlement are considered taxable income, legal fees are not fully deductible, leading to higher tax obligations for the injured party.
A legal professional can clarify how legal representation affects taxes on settlement proceeds and financial outcomes.
How an Experienced Attorney Can Help
Navigating the complexities of federal or state law in personal injury settlements requires expert guidance.
An experienced attorney can:
Evaluate settlement options to pursue fair compensation and address tax considerations
Guide you through compliance with IRS regulations and state laws
Structure settlements to manage potential tax impacts
Represent you effectively in wrongful death and personal injury cases
Get Legal Help for Your Personal Injury Case
Personal injury settlements involve intricate legal and tax implications. Whether dealing with medical expenses, lost wages, punitive damages, or wrongful death claims, understanding how federal and state laws impact compensation is crucial. Seeking help from a personal injury lawyer at Bourassa Law Group ensures that injured parties receive fair compensation while minimizing tax burdens.
If you or a loved one has been injured, contact us today for a free consultation.
1-800-870-8910