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When to pay taxes on personal injury settlements

On Behalf of | Oct 19, 2020 | Personal Injury |

When people suffer injuries and receive compensation for their pains, it seems unfair that they should pay taxes on this money. However, the most recent tax reform made this necessary, in some instances. When this happens, the federal government may decide to tax the money received as income.

Forbes explains that compensation received for physical sickness and physical injuries may remain tax-free. Damages paid for emotional distress and related physical symptoms may not qualify for tax-free treatment. When courts award punitive damages for any type of case, the individuals may also end up paying a significant portion in taxes for this.

The chicken-and-the-egg dilemma

Individuals making claims related to both emotional distress and physical illness may face the murkiest gray area. It creates an instance of trying to determine which came first. If the physical illness resulted from emotional distress, then the individual may need to pay taxes. However, if the individual can show how the incident led directly to physical illness, which then led to emotional distress, he or she may get to exclude the settlement from taxable income.

The effect of deductions

Prior to the tax reform, individuals had the opportunity to deduct legal fees related to the case. Now, the federal government taxes the full amount received. An exception exists for businesses facing litigation. The owners may write off the legal fees as business expenses. Another exemption exists when employees make whistleblower claims against employers.

Cornell Law shares the opinion of many tax professionals. It states that the new laws only further complicated an already complex area. Even so, plaintiffs may need to prepare for the impact of these tax treatments by working with financial professionals.