Since tomorrow is the deadline to pay income taxes, if you received a personal injury settlement last year, you might be wondering if you need to report that amount to the IRS as income.
Most of the time, your damages for your medical bills and pain and suffering are not considered income and are not taxable. This can save you a bundle of money. But this sometimes depends upon how those damages are categorized.
The damages for your personal injuries are not taxable, except for any related medical expenses you deducted in prior years and for which you already received a tax benefit. You cannot also deduct these medical bills on your 1040. Damages you received for emotional distress and anguish are treated the same way.
More good news: Texas does not assess its 8.25% sales tax on settlements, allowing an injured person to receive even more money.
On the other hand, lost wages or lost business profits resulting from your accident injuries have to be reported. They replace your earnings, which would have been taxed had you not been injured. The IRS also taxes punitive damages.
With the lack of income, payroll, and state sales taxes, the injury award can be worth many thousands of dollars more.
More information is here.
What About A Confidentiality Clause — Is That Taxable?
Corporate and well known defendants have an incentive to keep settlements confidential. What’s the harm in you agreeing not to talk about it? You weren’t planning to post it on Facebook or tell any one. But beware, that confidentiality clause could cost you money.
The IRS views the confidentiality provision as having a value that is taxable. Its viewpoint is based upon basic contracts law where a binding agreement must be mutual and have consideration. In the case of a confidentiality clause, the mutual agreement is that you will not divulge the terms of your settlement in exchange for payment on damages. The consideration is be the amount the defendant paid to compensate you for your silence.
The Tax Court has found that a plaintiff must receive “sufficient and clearly stated consideration” in return for his confidentiality. If the parties fail to do so, the IRS has discretion to assign a “just and fair amount” as the portion of the settlement that is consideration. This is a decision I would not leave to the IRS.
In a well-known case, cameraman Eugene Amos sued the controversial NBA player Dennis Rodman when the star basketball player kicked him in the groin during a game. The parties settled the claim for $200,000. Rodman wanted to keep the matter confidential and insisted upon a confidentiality clause. The IRS claimed that the full $200,000 was compensation for the confidentiality which would have made the entire judgment taxable. In the end, the U.S. Tax Court ruled that Amos had to pay taxes on $80,000 of the amount.
Language is Key
Throughout negotiations, an injury lawyer considers the tax implications to his client. Describing that settlement agreement in clear and accurate language is equally important.
Another rule of thumb is to never allow a confidentiality provision to be tacked on to a settlement. If the defendant wants confidentiality, the attorney will negotiate to receive fair value as consideration and include clear language in the settlement document.
In complicated injury cases, the lawyer may refer clients to a certified public accountant or tax attorney for further guidance, as these issues can make a huge difference in how much money you receive.
Please contact my office if you have any questions.