Personal Injury

Do I have to pay income taxes on my personal injury settlement? It depends on the type of case and the reasons why the money was paid.  There are numerous areas in personal injury settlements with potential income tax consequences: 1) punitive damages; 2) damages for emotional distress; 3) the consideration paid for a confidentiality agreement; (4) money paid to compensate for lost income; and (5) money paid to compensate for medical expenses. (See Section 104 of the Internal Revenue Code.) Florida's punitive damages statutes are contained in Chapter 768. While pleading punitive damages may increase settlement value, it will also create exposure for tax consequences. The advantages should be weighed against the disadvantages. The exclusion of damages in Section 104 for "physical injuries" or "physical sickness" does not include emotional distress damages which are unrelated to physical injuries. See Rivera v. Baker West, Inc., 430 F.3d 1253, 1256 (9th Cir. 2005). Importantly, the emotional distress noted here is not the same as the pain and suffering claimed in the ordinary personal injury case in which clients recover damages for both physical injuries and the emotional distress resulting therefrom, because this type of emotional distress arises "on account of personal injuries." The Service has consistently held that compensatory damages, including lost wages, received on account of a physical injury are excludable from gross income. Rev. Rul. 85-97, 1985-2 C.B. 50, amplifying Rev. Rul. 61-1, 1961-1 C.B. 14. See also Commissioner v. Schleier, 515 U.S. 323, 329-330 (1995), in which the Supreme Court, employing a similar set of facts as the ruling, held that medical expenses not previously deducted, pain and suffering damages, and lost wages received by accident victim are excludable from income.