So You Have Won Your Injury Settlement - Will The IRS Tax Your Award?
Guest Blogger Tax Expert Mary E. King Explains Personal Injury Awards and IRS Tax Issues
As the year draws to a close, with the Fiscal Cliff hanging over all of our collective heads, those who also have had the misfortune to sustain a personal injury accident may also be trying to accomplish some year-end tax planning.
With that in mind, the question may now be arising of, “Will my personal injury settlement be counted as income to me on my 2012 Federal Income Tax Return?” Excellent question!
The answer is probably not. As a general rule, most personal injury settlements are for what are known as compensatory damages; ie. Compensating you for your pain and suffering. In those cases, the money (compensation) that you receive, is not taxable. The specific IRS Code section which is applicable is IRC § 104(a)(2).
However, if you receive a special type of damages, called punitive damages, those damages are taxable as income. Punitive damages are the type of damages which are intended to punish the person or entity which caused you harm. The United States Tax Court in Bagley v. Commissioner, 105 T.C. No. 27 (1995) held that punitive damages are taxable income.
It is important that you, your personal injury attorney and your tax advisor determine what portion of your settlement is compensatory damages and what portion, if any, is punitive damages.