Can the IRS Take My Settlement Check?

Whether your settlement check is taxable depends on what it compensates you for. There are many types of potential damages in a personal injury case, and generally, these payments are not considered part of your gross income. One reason to hire Aaron Hicks is that he can structure your settlement to reduce your tax exposure.

Orange County personal injury attorney Aaron Hicks helps his clients negotiate the best settlement possible, given the facts of your case and applicable California law. He can be part of the team, putting your life back together after a severe accident.

Fill out our confidential contact form or call our office at (949) 541-9944 to schedule a free consultation regarding your auto accident with Mr. Hicks today.

What Does Tax Law and Regulations Say About Person Injury Settlements?

The Internal Revenue Service (IRS) states that whether a settlement is taxable depends on what the payment is intended to replace. The general rule is that income is taxable unless there’s an exception. That’s spelled out in IRS Section 61, which states in part, “Except as otherwise provided in this subtitle, gross income means all income from whatever source derived…”

IRS Section 104 states in part:

“…gross income does not include…(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness…”

IRS regulation Section 1.104-1(c) states that “other than punitive damages” in the statute doesn’t apply to a punitive damages award in a wrongful death case where state law only allows for punitive damages. That’s not the case in California, so compensation for punitive damages would be taxable.

The issue of taxability of personal injury lawsuit recoveries was brought up in a 1995 US Supreme Court decision. Citing IRS Section 104, the majority had this to say about it:

‘Assume that a taxpayer is in an automobile accident, is injured, and as a result of that injury suffers (a) medical expenses, (b) lost wages, and (c) pain, suffering, and emotional distress that cannot be measured with precision. If the taxpayer settles a resulting lawsuit for $30,000 (and if the taxpayer has not previously deducted her medical expenses, see § 104(a)), the entire $30,000 would be excludable under § 104(a)(2). The medical expenses for injuries arising out of the accident clearly constitute damages received “on account of personal injuries.” Similarly, the portion of the settlement intended to compensate for pain and suffering constitutes damages “on account of personal injury.” Finally, the recovery for lost wages is also excludable as being “on account of personal injuries,” as long as the lost wages resulted from time in which the taxpayer was out of work as a result of her injuries.’

The case involved a plaintiff who settled an age discrimination case. The court stated that while the statute’s plain language refers to personal injury cases, wages recovered in such a case would be taxable income.

What Does the IRS Say About Taxing Personal Injury Settlements?

The IRS has held that compensatory damages, including lost wages, received for a personal physical injury, except punitive damages, are excluded from gross income. Compensation for mental and emotional distress caused by non-physical injuries can also be excluded from gross income taxes if it is related to a physical injury or sickness.

A tax provision cited in the settlement agreement describing the payment can result in its exclusion from taxable income. We include this in all our settlement agreements to help our clients because the IRS probably won’t override the parties’ intent. We clarify that the compensation is due to personal injuries (not punitive damages).

If the settlement agreement doesn’t mention the taxable income issue, the IRS may investigate the defendant’s intent to determine whether the settlement is taxable. This is a complication that neither party wants to deal with.

Aaron Hicks is an Orange County Personal Injury Lawyer You Can Trust

If another party causes injuries to you or a loved one, Aaron Hicks at the Hicks Law Firm will help in any way he can. He is an experienced Orange County personal injury lawyer representing clients throughout Orange County and Southern California, including Costa Mesa, Irvine, Tustin, Newport Beach, and Huntington Beach.

Aaron Hicks has represented many injured plaintiffs and looks forward to helping you, too.