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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 taxable or not.
In this post, we discuss various tax issues you should have in mind concerning your personal injury settlement.
What is a personal injury settlement?
A personal injury settlement is an out of court agreement between the parties involved in a lawsuit. A settlement occurs when the defendant or his 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 upon due to personal injury lawsuits such as auto accidents, workplace accidents, product liability, medical malpractice, assault, and wrongful death.
After agreeing on a settlement amount, the parties renounce their right to pursue further legal action or monetary compensation. Settlements are ideal as jury verdicts are not always guaranteed.
Tax laws regarding personal injuries or physical sickness
Before 1996, personal injury settlements were normally tax-free and included damages such as defamation and emotional distress. After 1996, the personal injury had to be ‘physical’ in order for the tax exemption law to apply.
Proceeds from a personal injury that results in physical sickness or personal injuries are not taxed either by the 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 the damages such as medical bills, pain and suffering, emotional distress, attorney’s fees, and other damages directly related to the physical injury.
Personal injury tax laws exceptions
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 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.
Punitive damages are meant to punish the defendant over his negligent or irresponsible conduct. As punitive damages are not awarded along with compensatory damages, they are taxable.
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 taxable.
Tax laws regarding the confidentiality clause
The plaintiff may opt to sign the 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.
How can a Dallas, TX personal injury lawyer help?
A competent lawyer attorney should explain the tax implications 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 Dallas, TX 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.