In March of 2008, the California appeals court upheld a verdict awarding $82.6 million dollars to a woman who was paralyzed in a car accident as a result of a defective design in her car. Of this amount, almost $30 million was to cover the cost of her injury, immediate and ongoing medical expenses, medical equipment, physical therapy, counseling, as well as support for permanent disability. There is also money available for future health problems that may arise as a result of this injury. The remaining money, over $50 million, is for punitive damages. This is compensation for the emotional trauma of being in the accident and now being paralyzed for the rest of her life.
This case raises an interesting question regarding taxes on lawsuit settlements. Was this woman required to pay taxes on $82.6 million? Although this information is not available in the case report, chances are she was not required to pay taxes on most of that amount. According to Internal Revenue Code Section 104(a)(2), settlement money received for personal injury is excluded from taxation. That amount will not appear on your income tax return. Interestingly, the code does not define exactly what is legally seen as “personal physical injury.”
In the past, the Tax Court has set precedents allowing for pain and suffering to be excluded from taxation as long as the pain is physical pain. Additionally, the tax law states that compensation for emotion distress is not covered. However, precedents have been set to exclude compensation for emotional pain if the emotional pain is a direct result of a physical injury. For example, the paralyzed California woman can rightfully claim that the emotional pain she experienced following the accident was a result of coming to terms with being paralyzed.
Technically, punitive damages are suppose to be included as part of gross income. However, there have been cases that argued otherwise and were granted exception. Additionally, any part of the punitive damages that is included as part of your income is tax deductible. Contingent fess and money paid to receive the damages of a nonphysical personal injury are also tax deductible.
Did you know?
Structured settlements are often used as a means of ensuring the plaintiff receives the benefits of the settlement money over a long period of time.