After years of lost work, repeated visits to doctors, repeated diagnostic testing, surgery or other painful procedures, physical therapy, ongoing pain, and an inability to do the things you enjoy, not to mention years of litigation to be compensated for these harms and losses caused by someone’s carelessness, you have finally received your just due in financial remuneration. Is Uncle Sam entitled to any portion of that?
The IRS code1 states, so long as the settlement or award is on account of physical injury or physical sickness, there will be NO tax to pay.
Often times a settlement or award for physical injuries may include payments for lost wages or past medical costs, or may compensate someone who is not the injured party, like a spouse or beneficiary of a deceased. These are also excluded from taxation2.
However, damages purely for emotional harm, not as the result of a physical injury, are taxable. We often represent persons injured due to a sexual assault, for example. There may be no physical injuries suffered but monumental psychological harm which manifests itself in physical complaints like headaches, sleeplessness, anxiety, depression and suicide attempts. The IRS has ruled that damages from a claim for sexual harassment may be excluded from income only if the harassment involves “observable bodily harms” as opposed to emotional distress manifested by physical symptoms. So, for example, the IRS has excluded from income an award to an employee who suffered a heart attack as the result of his employer’s conduct (Parkinson v. Commissioner)or where an employee claimed a hostile work environment aggravated her multiple sclerosis (Domeny v. Commissioner).
The tax consequences of your personal injury award or settlement should always be discussed with your accountant. We at BRB are not tax advisors however, we do consider the tax consequences of your potential and or actual recovery in both framing the allegations of your claim and in the documents memorializing the resolution of the case. It is your duty to properly account for all income to the IRS, including any personal injury award or settlement.
1 Pursuant to IRS Code, IRC Section 104(a)(2), and its regulations
2The House Report to the Small Business Job Protection Act of 1996 provided: “…(I)f an action has its origin in a physical injury or physical sickness, then all damages (other than punitive damages) that flow therefrom are treated as payments received on account of physical injury or physical sickness whether or not the recipient of the damages is the injured party.” H.R. Rep. No. 104-737.