The attorney way to answer this question is, I’m not a tax lawyer, but I could refer you to someone. This may not be necessary considering the majority of personal injury settlements are not taxable. That being said, as a general, abstract principle, it is incorrect to say that personal injury settlements are never taxed. (Good time to note: this post should not be relied upon as tax advice.) Personal Injury carries very few definitive answers to every legal question.
Are There Laws or IRS Codes?
Per the IRS “all income is taxable from whatever source derived unless exempted by another section of the Code” IRC Sec. 61
26 C.F.R 1. It states, in pertinent part:
§1.104-1 Compensation for injuries or sickness.
(c) Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.
What About Pain and Suffering?
Pain and suffering is often the icing on the cake in a successful trial and could make up the majority of a client’s damages. One caveat to pain and suffering is if you claimed a medical expense deduction for costs that are ultimately reimbursed through a verdict or settlement, the IRS requires that you “recapture” the previously deducted amount by reporting it as income.
Property Damage Is Likely Not Taxable Either
Property settlements are generally not taxable. The IRS says that if the loss in value of the property is less than the adjusted basis of your property, then it is not taxable although you must reduce your basis in the property by the amount of the settlement (if you are amortizing the property for tax purposes). So if the settlement exceeds your adjusted basis in the property, the excess is income it should be recaptured.
Compensation for Lost Income or Lost Business Also Not Taxable
In personal physical injury cases, any portion of the recovery for lost wages is not subject to income tax. See 26 U.S.C. § 104(a)(2)
The Exception Involves Dennis Rodman – Confidentiality and Non-Disparagement Settlement Clauses Are Taxable
A confidentiality clause prohibits the parties to a settlement from disclosing the settlement terms and/or details about the case. The IRS concluded — in a case involving Dennis Rodman — that this portion of a settlement is taxable. This is not a normal personal injury case, but it is an exception to the rule that personal injury settlement are not taxable.
Punitive Damages and Interest Are Taxable
In Florida, punitive damage awards are taxable if they are go beyond compensating you for your loss. They may need to be reported as “other income”.
Getting Help from a Lawyer
If you need a tax lawyer, you should not be calling Quattrochi, Torres, and Taormina. But if you have a personal injury, property damage, homeowners insurance or medical malpractice case, call one of our lawyers at 407-986-4120.