Is a Personal Injury Settlement Taxable in Texas—and What Should You Do With the Money?

Receiving a substantial personal injury settlement can provide much-needed financial security after a serious accident. It can also create an entirely new set of questions.

Is the settlement taxable? Does it change your estate planning needs? Should the funds be held or managed differently? And what happens to those assets if you become incapacitated or die?

The answers depend on both the nature of the recovery and your individual circumstances.

When Is a Personal Injury Settlement Taxable?

Federal tax law generally excludes damages received because of personal physical injuries or physical sickness from gross income. However, that does not mean every dollar recovered in every personal injury case is automatically tax-free.

The character of the damages matters.

Compensatory damages attributable to a physical injury or physical sickness are generally treated differently from punitive damages, which are generally taxable. Emotional distress damages may also receive different treatment depending on whether they stem from a physical injury or sickness.

There can be additional complications when a settlement reimburses medical expenses that produced a tax benefit in a prior year.

For these reasons, anyone receiving a significant settlement should have the specific settlement documents and circumstances reviewed rather than assuming the entire recovery will receive the same tax treatment.

A Settlement Can Change Your Estate

For someone who has never considered themselves to have a substantial estate, a significant personal injury recovery can change that very quickly, often leaving the family overwhelmed with questions.

The settlement may become one of the individual’s largest assets. That makes it important to consider what happens to those funds not only today, but if the recipient later becomes incapacitated or dies.

Questions may include:

• Does an existing will or trust still accomplish your goals?
• Who will have authority to manage financial affairs in the event of incapacity?
• How should settlement assets pass to a spouse, children, or other beneficiaries?
• Are there beneficiaries who may require additional planning because of age, disability, financial circumstances, or other considerations?
• Do beneficiary designations and other non-probate assets coordinate with the overall estate plan?

A settlement does not automatically mean that sophisticated estate planning is necessary. But a significant change in wealth is a good reason to review an existing plan—or create one if none exists.

“A substantial settlement can change a family’s financial picture overnight. The legal case may be finished, but the planning should not stop there. The next question is how those assets should be protected, managed, and ultimately transferred according to the client’s wishes.”

-Don Ford, Board Certified Estate Planning Attorney

Start With the Personal Injury Case

Estate planning cannot substitute for experienced representation in the underlying personal injury matter.

For individuals injured in Texas, personal injury attorney Chaile Allen of The Law Firm of Chaile Allen represents clients in serious injury cases and other civil litigation. An experienced personal injury lawyer can evaluate the underlying claim, identify potentially recoverable damages, negotiate with insurers, and pursue the full compensation available under the law.

Once a settlement or judgment has been reached, the appropriate tax, financial, and estate planning professionals can help the client evaluate what comes next.

When a Financial Recovery Should Prompt an Estate Plan Review

Estate plans should evolve as a client’s life and financial circumstances change. A significant personal injury settlement is one of several events that may justify reviewing existing documents and planning strategies.

At Ford + Bergner LLP, Managing Partner Don Ford is Board Certified in Estate Planning and Probate Law by the Texas Board of Legal Specialization. The firm focuses on estate planning, probate, guardianship, and estate, trust, and guardianship litigation.

If you or a family member has received a substantial settlement or other financial recovery, an estate planning review can help determine whether your current plan continues to protect your assets and carry out your intentions.