The impact of serious accidents can be life changing. Whether from an auto accident, slip and fall, drug or medical device case, medical malpractice, or industrial accident, the resulting physical and emotional injuries can greatly affect us. Luckily, these serious accidents are capable of producing tax-free money for plaintiffs. Compensatory damages for physical injuries or sickness should be tax-free. However, punitive damages unfortunately, are not. Punitive damages and interest are subject to taxes. The Trump administration is executing some additional changes under its tax law. Now, in order to qualify for tax-free awards, the injuries experienced must be physical. The IRS now says that physical symptoms such as insomnia, headaches, and stomachaches do not count as physical injuries, because they are normal byproducts of emotional distress, which is not enough to recover.
What Exactly is Considered to be a “Physical” Damage?
However, there has been some confusion as to what exactly is to be considered “physical” – especially if claims for emotional distress result in taxable damages. If a plaintiff is able to prove that their insomnia, headaches, and or stomachaches are physical injuries, which have been caused by the defendant’s actions, the resulting damages should be tax-free. On the other hand, if you claim that the emotional distress that you have experienced has resulted in physical illness, damages will remain taxable. Even more confusing, if you have experienced physical damages and those damages produce emotional distress as well, then the emotional damages should also be tax-free. If you are working with a contingent fee attorney, for tax purposes the plaintiff will be treated as having received 100% of the damages, allowing for any attorney payments to remain tax-free.
What Are the Tax Ramifications?
The concern arises if one’s recovery is totally or partially taxable. Even if you use a portion of your award to pay attorneys fees, from a tax perspective you are considered to have received 100% of the income. Until the end of 2017 individuals could claim a miscellaneous itemized tax deduction of up to $40,000.
However, beginning in 2018, legal fees receive no deduction. This would mean that you could collect 60% of the award, but continue to be taxed on 100% of it. Not all attorneys’ fees receive this tax treatment – if the lawsuit is in regards to a plaintiff’s business or trade, the legal fees are considered to be a business expense and can be deducted “above the line.” This ends up as if from the beginning the income was never received. The same applies if your case involves claims against your employer or if it involves specific whistleblower claims: legal fees are considered an above-the-line deduction. Sometimes it is possible to get around this attorney fee tax, but requires sophisticated tax help and is still not promised. Furthermore, interest is always taxable. It is always a good idea to seek tax advice prior to a personal injury settlement in order to ensure that you receive the best possible outcome.
Posted in: Personal Injury