Do I Need To Pay Taxes On Personal Injury Settlement  

Prior to August 20 1996, personal injury recoveries were not liable to federal tax. Constitutional amendment Section 104(a)(2) of the Internal Revenue Code decreed that ‘Punitive damages are intended to punish the wrongdoer and not intended to compensate the claimant.  Thus, they are a windfall to the taxpayer and appropriately should be included in taxable income.’

Hence, all punitive damage is taxable even if received in compensation of physical injury or physical sickness.

This however requires clarification. The amendment went on to clarify certain exclusions from gross income. This was the amount of damages other than punitive on account of personal injuries or physical sickness. Emotional distress does not come under the purview of physical injury or physical sickness. To amplify further, the following are exclusions in a personal injury settlement:

  1. Punitive damages for Special Wrongful Death Circumstances
  2. Compensatory damages for:
  3. Physical Injuries Accompanied By Emotional Distress
  4. Wrongful Death
  5. Lost Wages “On Account Of” Physical Injury Or Sickness
  6. Lost Consortium Due to Spouse’s Physical Injury
  7. Bystander Claims of Negligent Infliction Of Emotional Distress
  8. Medical Expenses Incurred, including those expenses attributable to emotional distress
  9. Attorney’s Fees Associated with Nontaxable Damages
  10. Interest Component of Otherwise Nontaxable Structured Settlements
Furthermore, it is incumbent on the attorney to advise his client that damages or settlements are liable to income tax. Personal injury attorneys should refrain from rendering tax advice. The onus of proving that certain items of a settlement or award are non-taxable vest with the recipient of the benefit.

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