Woodland Hills personal injury lawyer Barry P. Goldberg starts receiving phone calls around this “tax time” of year from clients asking whether their personal injury settlements must be declared and are taxable. I always answer the question the same way, I am not qualified to provide tax advice. In fact, I “glazed over” in law school whenever the subject of taxes were discussed. However, I am in a position to tell clients that “it depends!”
I know that there are several general rules which apply to a typical personal injury settlement which I have read from tax and financial experts much more qualified than me to address these issues. Under Section 104(a), which provides that “income” does not include any lawsuit damages (other than punitive damages) received on account of “personal physical injuries of physical sickness.”
Apparently, “emotional distress” —- standing alone—- is not treated as a physical injury or physical sickness. A well-respected local CPA explained that the legislative history to Section 104 clarifies that physical symptoms arising from emotional distress–like insomnia, headaches, or stomach disorders–are also not considered personal injuries or physical sickness. He further explained that there is authority for the proposition that depression and anxiety are non-physical injuries, are also not considered personal injuries or physical sickness.
The important inquiry is to determine the genesis of the legal claim. If the genesis of the legal claim is emotional distress, then the full amount of compensation — even if meant to make you whole for resulting physical symptoms — may be taxable. A good example of this may be a claim for Intentional Infliction of Emotional Distress or a Fraud claim arising from a business deal which causes severe emotional distress.
However, if the genesis of the claim is a physical injury, then the full amount of the payment — other than punitive damages — may be excludable under Section 104, even if part of the payment is meant to compensate you for emotional distress arising from the physical injury. This circumstance appears to fit the average automobile accident or trip and fall case. An injured neck or back which requires treatment and a possible surgery will necessarily include “emotional distress” and other mental conditions associated with the physical injury.
The tax analysis becomes much more complex when the claim involves loss of earnings and wrongful termination damages. The analysis in these types of cases is the proper subject for a qualified tax expert, tax lawyer or Certified Public Accountant. Each State may have its own rules regarding personal injury settlements, as well! Given that I am a humble personal injury trial attorney, my office is simply unqualified to provide tax advice of any kind! Accordingly, the question of whether your settlement or verdict is taxable is properly the subject that must be asked of your expert in connection with your particular tax preparation.
