According to the IRS, “all income is taxable” from whatever source derived unless exempted by another section of the Code.” If your Dallas, TX personal injury lawyer has helped you come to a settlement during the previous tax year, you may be wondering whether the money is considered part of your income.
In this post, we answer the question, “Is my personal injury settlement taxable?” while discussing other various tax considerations you should have in mind concerning your settlement. Let’s take a closer look.
A personal injury settlement is an out-of-court agreement between the parties involved in a lawsuit. These lawsuit settlements occur when the defendant or their insurance carrier offers to make a payment after liability is established.
The settlement offer can be made either before or after the lawsuit is filed. A settlement may be reached due to personal injury lawsuits such as auto accidents, workplace accidents, motorcycle crashes, product liability, biking and cycling accidents, medical malpractice, pedestrians struck by vehicles, truck wrecks, and wrongful death.
After agreeing on a settlement amount, the parties renounce their right to pursue further legal action or monetary compensation. Settlements are typically ideal for taxes and tax planning, as jury verdicts are not always guaranteed, and judgments can be difficult to predict.
Before 1996, personal injury settlements were normally tax-free and included damages such as defamation and emotional distress. However, beginning in 1996, a personal injury had to be considered “physical” in order for the tax exemption law to apply.
Exactly which injuries or sicknesses are “physical” can be unclear. For example, damages from an incident that caused a defendant to become physically sick directly would be tax-free, while an action that caused emotional distress intense enough to lead to physical sickness would not amount to tax-free damages.
In this example, the latter is not considered a case where a personal injury or sickness is considered “physical.” The IRS has established that the presence of physical symptoms – such as stomachaches or insomnia – can be considered normal byproducts of emotional distress, a claim that does not award tax-free damages.
Proceeds from personal physical injuries or physical sickness are not taxed either by state or federal laws. This rule applies whether you settled the case before or after you filed a lawsuit or if your case went to trial. This rule extends to damages such as medical expenses, pain and suffering, worker’s compensation, attorney’s fees, and other damages directly related to the physical injury.
As with all laws, there are exceptions to the personal injury tax rule. For instance, even though you may have suffered a physical injury, your settlement could be subject to taxes if your lawsuit was based on a breach of contract. Verdicts or settlements that a plaintiff receives based purely on emotional damage are taxable. In addition, if your settlement includes a lost wage claim, you will only receive the net after-tax sum.
Another exception to consider is punitive damages, which are meant to punish the defendant for their negligent or irresponsible conduct. Because punitive damages are not awarded, they, along with compensatory damages, are taxable.
Additionally, most courts award interest on the amount of money the parties agree on. This is accrued from the date the lawsuit is filed to the date the defendant pays fully. The interest amount is treated as income and is, therefore, taxable.
A confidentiality clause, or non-disclosure agreement (NDA), is a provision that prohibits parties from sharing or copying proprietary or confidential information. In the case of lawsuit settlements, the plaintiff may opt to sign a confidentiality clause if they are angry or frustrated by what happened to them. On the other hand, this clause is appealing to defendants if they fear that agreeing to a settlement is an indication of guilt.
While the confidentiality clause may appear appealing as it prohibits the parties involved from disclosing the settlement details and terms, the settlement amount, in this case, is taxable.
This rule came about after the case involving Eugene Amos, a cameraman who sued Dennis Rodman, an NBA player, for kicking him in the groin as he covered a basketball game. The parties arrived at $200,000 as the settlement amount. Rodman wanted to keep the details of the case under wraps and, therefore, insisted on including the confidentiality clause. The IRS claimed that the $200,000 was compensation for Eugene’s silence, which made it taxable. In the end, he had to pay taxes amounting to $80,000.
Following the case, the Tax Court ruled that the plaintiff must have “sufficient and clearly stated consideration,” in the absence of which the IRS can allocate a “just and fair amount” as the tax amount.
If you are pursuing a personal injury settlement, the advice of a qualified professional can help you effectively plan for any anticipated tax burdens. A competent lawyer and attorney should explain the tax implications of a personal injury settlement to you throughout the negotiations. As there may be more than one claim, a portion of the settlement amount may be taxable while the other is not.
A Texas personal injury lawyer will help you keep the awards separate. In the event that the IRS challenges your non-taxable settlement verdict, you have a higher chance of keeping it that way if you have an experienced attorney by your side.
So, while the answer to the question, “Is my personal injury settlement taxable?” may not always have a simple answer, working with a qualified legal professional can help you get the answers you need and plan accordingly. If you have queries when it comes to the taxability of your personal injury settlement, contact Thompson Law online or call us at 844-308-8180 for a free case review.
Thompson Law receives an attorney fee and you pay no legal fees as our client unless we pay you. Thompson Law has 350 years of combined experience in legal representation and has won over $1.8 billion dollars in cash settlements for our clients. We master the art of managing client cases with empathy, compassion, respect and, of course, prodigious skill. Contact us today for a free, risk-free consultation to discuss your accident and your options.
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