Taxes and Personal Injury Lawsuits
It seems like there is always someone waiting to take a chunk out of every dollar a person makes. Between taxes, social security, and debt collectors, everyone wants a piece of the pie. The government has even allowed creditors to take money from individuals’ CARES Act stimulus package payments. This is being debated nationwide, as these checks are intended for relief from the coronavirus pandemic. These types of transactions feel like theft, but some would argue that they have their place in protecting the economy. However, a person receiving a personal injury settlement or judgement is not earning that money. Instead, they are receiving that money to compensate for a loss. Taxes and personal injury lawsuits are not always an issue as a result of this fact, but they can be.
Tax-Free Elements of Florida Personal Injury Settlements
The Internal Revenue Service (IRS) will generally not tax most of the elements of your award. This includes any compensation for physical injury or illness. It also includes compensation for emotional distress due to the injury or illness. If the courts award compensation for medical expenses, the IRS will consider this exempt. However, you must report medical expense reimbursement, so the IRS can adjust your medical expense deduction (if applicable). Compensation for lost wages due to an injury may or may not be subject to taxes. It is possible that there could be exceptions to any of these items depending on unforeseeable circumstances, but this is generally how the IRS handles these parts of a settlement.
Taxed Elements of Florida Personal Injury Settlements
There are some elements of a personal injury judgement that the IRS treats as income and therefore will tax. For instance, the IRS considers punitive damages somewhat unrelated to making you “whole” again through the process of a lawsuit. It considers punitive damages above and beyond compensation and therefore taxes it as income. Any interest earned from the compensation is also taxed. This happens when a person invests their court award and ends up making additional money off of it through interest, dividends, etc.
Some taxable compensation from personal injury lawsuits is less clear-cut. For example, if the courts compensate you for lost wages, the IRS may consider it taxable income. This could include any settlement received for wrongful termination because it qualified as compensation for lost wages. Defamation, discrimination, and harassment damages may also qualify as income. The IRS determines this based on whether or not it was responsible for your injuries, so these items are taxable based on the specifics of the case.
What About Taxes and Attorney Fees?
In many personal injury cases, you pay the lawyer only if you win your case. This is called a contingency fee. Whether or not you have to include contingency fees in your income depends on where you live in America. In Florida, the United States Court of Appeals for the 11th Judicial Circuit decided that taxpayers DO NOT need to include contingency fees in their income. However, there are many other districts that require taxpayers to list contingency fees and then deduct them.
Why the Difference in Regard to Contingency Fee Taxes?
The difference in the courts’ opinions on contingency fee taxation is interesting, and both arguments make sense. Florida argues that since a plaintiff has no obligation to pay an attorney unless they win, they have no personal liability for attorney fees. Therefore, in a sense, the plaintiff is never really in contact with that money. Other courts who disagree with the 11th Circuit say that since the contingency fee is only paid through judgement to a plaintiff, the plaintiff is the one who technically receives the award. Therefore, the plaintiff must count contingency fees as income. The courts have basically boiled the argument down to who controls the lawsuit, the lawyer or the plaintiff. It could be argued that either do, or it could be argued that both do. Therein lies the crux of the argument.
What if Taxes Take My Entire Settlement?
A plaintiff in a personal injury case should seek tax assistance before agreeing to any settlement, as taxes and contingency fees can take up a large portion of your settlement. Sitting down with an accountant or other tax professional can give you better insight into how the IRS will tax your settlement, your contingency fee, and how any deductions may be applied. The intent of the court’s judgement is to provide you with economic relief that you deserve because your injuries were the fault of another person’s actions or negligence. If taxes take the majority of your settlement, the courts are not serving that purpose.
Evolution of Taxes and Personal Injury Lawsuits
Over the years, the courts have adjusted their opinions on what constitutes bodily harm and therefore excludable compensation on the taxation of personal injury judgments. Physical injury and physical sickness are unquestionably excludable, but what if those injuries are not visible? A heart attack caused by emotional distress may difficult to prove causation. However, the courts have considered exacerbation of medical conditions due to workplace conditions physical injury. They’ve also considered mental anguish due to sexual abuse a “physical” injury. It can be difficult to determine how the IRS will determine “physical” injuries and illness, which is why it is important that legal teams draft proper settlement agreements to reduce ambiguities.
Settlement Agreements Help Determine Taxation
If a settlement agreement only labels a part of a settlement as “non-economic damages,” the IRS is bound to question it. Maybe it is directly related to the physical injury and thus untaxable, but the IRS cannot tell. They are more prone to taxation than just letting things go because they don’t have clarification. This can result in further hardship for the plaintiff.
Instead, lawyers should draft settlements in a very clean manner. The IRS and the plaintiff does not have to worry about the confusion that can come with settlements. Instead, drafters should clearly label each part of the settlement and properly connect it to injuries. In this way, a person can maximize their settlement and reduce the burden of taxation when things are not clear.
Taxes and Personal Injury Lawsuits are Worth Considering
When a person goes to file a personal injury lawsuit, taxes are not typically their first consideration. However, taxes can have a huge impact on the amount a person actually ends up receiving. This is especially true in large settlements where the percentages grow to huge amounts the plaintiff must turn over to the IRS. However, the smaller lawsuit can also see its award dwindle down to practically nothing if he or she has to pay taxes on it. The only way to determine how much of an impact taxes will have on your personal injury lawsuit is to talk to your lawyer and a tax professional. Look to your lawyer to see if you should agree to a settlement amount, or ask for more due to tax liabilities.
Finding Experienced Representation
An attorney with experience will be able to easily aid you through your tax law or at least offer a recommendation of a tax professional who can. If you are looking for an experienced law firm, contact Kirshner, Groff, and Diaz for a no-obligation consultation about your personal injury case. You’ll speak to an actual lawyer right away.