As a result of an accident a Plantation resident received a significant personal injury settlement and asked one of our tax consultants whether it is taxable.
If all or portion of the settlement were subject to tax he wanted to set aside money to pay the taxes as he did not want any IRS problems.
Generally, the amount of compensatory damages received as a result of a physical injury or sickness is excluded from income. The exclusion applies whether the damages are received from a lawsuit or a settlement agreement and can be received in a lump sum or as periodic payments. Although the award or settlement may be nontaxable, any amount considered interest must be included in income. The exclusion extends to the amount of the award for lost wages, even though the wages would otherwise be taxable if earned by the taxpayer.
A portion of the award may be taxable if you deducted medical expenses related to the physical injury or sickness in a prior year. The amount of medical expenses you deducted and received a tax benefit will be presumed to be recovered first out of the award proceeds and subject to tax.
Determining Whether Your Settlement is Taxable
The background of the Plantation taxpayer’s case is as follows:
In 2013, he was injured in an automobile accident and incurred unreimbursed medical expenses of $15,000 and had lost wages of $5,000 as a result of the accident. In addition, he suffered substantial pain attributable to his physical injuries. On his 2013 return, he deducted the $15,000 of medical expenses, of which $12,000 was actually allowed after applicable limitations.
During 2014, he reached a $ 200,000 settlement to cover his medical expenses, lost wages, and all other damages related to the accident. The settlement agreement did not provide any specific allocation of the $200,000 award.
The taxpayer can exclude $188,000 from income ($200,000 settlement award less the $12,000 tax benefit received from the medical deduction claimed in 2013). Thus, the taxpayer must report $12,000 of income from the settlement. The exclusion applies to the settlement portion that replaces his lost wages, even though, had he earned the wages, they would have been taxable.
Taxable Awards
Amounts received for employment discrimination, injury to reputation and emotional distress or mental anguish that does not originate from a physical injury or sickness is includible in your income. Punitive damage awards (awards to punish the wrongdoer) are taxable whether they relate to physical or nonphysical injuries.
If you would like additional information regarding the tax consequences of your settlement, please call our Boca Raton office and ask to speak with a tax consultant.