Gavin Howe
The Internal Revenue Service (IRS) considers settlement awards from personal injury lawsuits involving observable bodily harm as non-taxable income. However, the IRS treats settlement proceeds from non-physical injuries or sicknesses as taxable income. This includes punitive settlement amounts, interest, and lost wages. It is important to note that tax implications may vary based on state laws, and it is recommended to consult a licensed accountant for specific guidance on how lawsuit settlements are taxed.
| Characteristics | Values |
|---|---|
| Taxability | All income is taxable unless exempted by another section of the code |
| Taxable income | All amounts from any source are included in gross income unless a specific exception exists |
| Non-taxable income | Amounts paid for certain discrimination claims and amounts paid on account of physical injury |
| Taxable settlement proceeds | Non-physical lawsuits, emotional distress (non-physical), lost wages and back pay (non-physical), pre- or post-judgment interest |
| Non-taxable settlement proceeds | Physical injury, emotional distress (physical injuries), medical expenses (if not previously deducted on taxes) |
| Taxable attorney fees | Attorney fees are taxable and treated as income |
| Non-taxable settlement | Settlements for the loss in value of property that are less than the adjusted basis of your property |
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What You'll Learn
- The IRS considers most lawsuit settlement money as taxable income
- However, personal injury and physical injury settlements are exceptions
- Emotional distress damages without physical symptoms are taxable
- Lost wages, punitive damages, and interest on the settlement are taxable
- Settlement proceeds for medical expenses are non-taxable unless previously deducted
The IRS considers most lawsuit settlement money as taxable income
The Internal Revenue Service (IRS) considers most lawsuit settlement money as taxable income. This is based on the Internal Revenue Code (IRC) Section 61, which states that all income is taxable, regardless of its source, unless a specific exemption exists.
For example, certain parts of a lawsuit settlement, such as lost wages, punitive damages, or interest on the settlement, are typically taxable. This includes situations where the settlement compensates for lost wages that would have otherwise been taxed as income. Additionally, settlement awards for emotional distress not directly caused by physical injury are also generally considered taxable income.
However, there are important exceptions to this rule. Personal injury settlements, particularly those involving observable bodily harm, are generally not considered taxable income. This aligns with IRS Code § 104(a)(2), which specifically excludes damages received for personal physical injuries or illness from taxable income. As a result, car accident cases, slip and fall incidents, and medical malpractice lawsuits that result in physical injuries are typically exempt from taxation.
It is worth noting that each lawsuit claim is unique, and it is always recommended to seek guidance from a licensed accountant to understand the tax implications of any settlement money received.
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However, personal injury and physical injury settlements are exceptions
The IRS generally considers settlement money and damages collected from a lawsuit as taxable income. However, personal injury and physical injury settlements are exceptions. This is outlined in IRC Section 104(a)(2), which specifies that damages received on account of personal physical injuries or physical sickness are excluded from gross income. In other words, if the injuries are visible, the IRS considers compensation money awarded for those injuries as tax-free. This is true even if the settlement includes lost wages, as long as the loss was caused by a personal physical injury.
It's important to note that if you deducted medical expenses related to the injury in prior years, you might need to include a portion of the settlement in your income. Additionally, punitive damages received in a personal injury lawsuit are generally taxable. This includes any interest earned on the settlement.
The taxability of personal injury settlements can vary by state. Many states align with federal guidelines, generally excluding compensation for physical injuries or sickness from taxable income. However, certain states may have different rules, especially concerning compensation types like emotional distress. Therefore, it's always recommended to seek guidance from a licensed accountant to navigate the tax implications of lawsuit settlements.
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Emotional distress damages without physical symptoms are taxable
The IRS considers settlement money and damages collected from a lawsuit as income, and therefore categorizes it as taxable. However, there are exceptions to this rule, such as personal injury and physical injury settlements. In the state of Florida, for example, personal injury settlements are typically not subject to income tax, especially when they compensate for physical injuries or sickness.
Emotional distress damages without physical symptoms are generally taxable. In the case of Parkinson v. the IRS, the plaintiff sued in state court for intentional infliction and invasion of privacy. He alleged that his employer's misconduct caused him to suffer a disabling heart attack at work, rendering him unable to work. He settled and claimed that one payment was tax-free. The IRS disagreed, arguing that it was a taxable emotional distress recovery. The Tax Court overruled the IRS, stating that damages received on account of emotional distress attributable to physical injury or physical sickness are tax-free. The court distinguished between a "symptom" and a "sign", defining a symptom as "subjective evidence of disease of a patient's condition", while a "sign" is evidence perceptible to the examining physician.
To exclude a payment from income on account of physical sickness, the taxpayer needs evidence that they made the claim. They do not necessarily have to prove that the defendant caused the sickness, but they must show that they claimed it, and that the defendant was aware of the claim and considered it when making the payment. To prove physical sickness, the taxpayer should provide evidence of medical care and that they claimed the defendant caused or exacerbated their condition. The more medical evidence, the better.
It is important to note that the taxation of lawsuit settlements can be complex, and each case is unique. Seeking advice from a licensed accountant is always recommended, especially if you expect to receive a large payout.
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Lost wages, punitive damages, and interest on the settlement are taxable
In the United States, the Internal Revenue Service (IRS) considers all income taxable from whatever source derived, unless specifically exempted by another section of the code. This means that the IRS can tax proceeds from a lawsuit, and there are several types of damages that are taxable. Lost wages are taxable because they are considered income that would have been taxed if received without interruption. In addition to income tax, these wages are also subject to social security and Medicare taxes.
Interest on settlement money is also taxable and may influence taxes on attorney fees. Punitive damages are taxable as well. Certain parts of a lawsuit settlement can be taxable under federal law, but this varies by state. For example, in Florida, personal injury settlements are typically not subject to income tax, especially when they compensate for physical injuries or sickness. This aligns with IRS Code § 104(a)(2), which excludes damages received for personal physical injuries or illness from taxable income.
The IRS does not tax settlement awards from personal injury lawsuits if these cases demonstrate "observable bodily harm." So, if the injuries are visible, the IRS considers compensation money awarded because of those injuries tax-free. However, settlement amounts for emotional distress not directly caused by physical injury are taxable. This distinction is crucial, as only emotional distress stemming from physical injury qualifies for tax-exempt status. Any associated medical expenses that were deducted previously will also be taxable upon settlement.
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Settlement proceeds for medical expenses are non-taxable unless previously deducted
The IRS considers settlement proceeds from lawsuits as income, and therefore taxable, unless exempted by another section of the Internal Revenue Code (IRC). According to IRC Section 61, all income is taxable from whatever source derived. However, there are exceptions to this rule, and each lawsuit claim is unique.
One such exception is outlined in IRC Section 104, which states that damages received for personal physical injuries or illness are excluded from taxable income. This includes compensatory damages for observable bodily harm and medical expenses related to the injury or illness. As a result, settlement proceeds for medical expenses are typically non-taxable.
However, it is important to note that if you have previously deducted medical expenses from your taxes, you cannot deduct them again if you receive a settlement that covers those expenses. In other words, you cannot "double-dip" and claim the same expenses twice for tax benefits. This is because the settlement is simply repaying what you had already paid out of pocket for your medical care.
For example, let's say you were injured in 2019 and paid $50,000 in medical expenses. You claimed this as an itemized deduction on your 2019 tax return, resulting in a tax benefit. In 2020, you receive a $45,000 settlement for your injuries. While the settlement itself is non-taxable, you must repay the tax benefit you received in 2019. You would report this as "other income" or a “taxable recovery” on your tax return for the year in which you receive the settlement.
In summary, settlement proceeds for medical expenses are generally non-taxable unless those expenses have been previously deducted from your taxes. It is always recommended to seek guidance from a licensed accountant or tax professional to ensure you understand the tax implications of any settlement proceeds you receive.
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Frequently asked questions
The IRS generally considers settlement money and damages collected from a lawsuit as taxable income. However, there are exceptions, including personal injury and physical injury settlements.
The IRS does not tax settlement awards from personal injury lawsuits if the case demonstrates "observable bodily harm". Other exceptions include medical malpractice settlements and settlements for the loss in value of property that are less than the adjusted basis of your property.
It depends on the type of lawsuit and the types of damages awarded. It is recommended to consult a licensed accountant to determine the tax implications of your specific settlement. Additionally, reviewing court-related documents or other relevant documentation of the settlement can help identify how the settlement payment was processed.
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