Tax Aspects of Personal Injury Awards
The Small Business Job Protection Act, signed by President Clinton on August 20, 1996, ends years of litigation concerning the taxability of punitive damages and damages for non physical injuries such as gender and age discrimination.
Under the Act, punitive damages whether or not related to physical injury are not excludable from gross income. Awards for nonphysical injuries are excludable only to the extent of amounts paid for medical care attributable to emotional distress.
Under prior law, damages received as a result of personal injury or sickness were not included in gross income. This provision has been challenged by the Internal Revenue Service in recent years when the awards were for lost wages, punitive damages, damages to reputation and gender, race, and age discrimination.
The new law generally applies to amounts received after the date of enactment, August 20, 1996, in taxable years ending after that date. Prior law applies to amounts received under a written binding agreement, court decree or mediation award in effect on (or issued on or before) September 13, 1995.
Examples:
Mary Jones was awarded $ 50,000 for sexual harassment. The entire award was for pain and suffering. Since the payment was for a nonphysical injury, the entire amount would be included in her gross income.
Judy Allen was awarded $75,000 for sexual harassment. Of that amount, $ 50,000 was for pain and suffering and $ 25,000 was for medical expenses resulting treatment of the emotional distress caused by the harassment. The $ 25,000 payment for medical expenses would be excluded from Allen's gross income; she must include the remaining $ 50,000 for pain and suffering in income.
Sarah Jones was awarded $ 100,000 for physical injuries received from an automobile accident while making sales calls for her employer. The entire award was for the actual physical injuries she suffered and therefore would be excluded from gross income.
Wrongful Death Actions
Prior law continues to apply to punitive damages received in a wrongful death action if the applicable state law in effect on September 13, 1995 (the date the personal injury bill was first presented to the House Ways and Means Committee), provides or has been construed to provide by a court decision issued on or before that date - that only punitive damages may be awarded in a wrongful death action.
Under the Act, punitive damages whether or not related to physical injury are not excludable from gross income. Awards for nonphysical injuries are excludable only to the extent of amounts paid for medical care attributable to emotional distress.
Under prior law, damages received as a result of personal injury or sickness were not included in gross income. This provision has been challenged by the Internal Revenue Service in recent years when the awards were for lost wages, punitive damages, damages to reputation and gender, race, and age discrimination.
The new law generally applies to amounts received after the date of enactment, August 20, 1996, in taxable years ending after that date. Prior law applies to amounts received under a written binding agreement, court decree or mediation award in effect on (or issued on or before) September 13, 1995.
Examples:
Mary Jones was awarded $ 50,000 for sexual harassment. The entire award was for pain and suffering. Since the payment was for a nonphysical injury, the entire amount would be included in her gross income.
Judy Allen was awarded $75,000 for sexual harassment. Of that amount, $ 50,000 was for pain and suffering and $ 25,000 was for medical expenses resulting treatment of the emotional distress caused by the harassment. The $ 25,000 payment for medical expenses would be excluded from Allen's gross income; she must include the remaining $ 50,000 for pain and suffering in income.
Sarah Jones was awarded $ 100,000 for physical injuries received from an automobile accident while making sales calls for her employer. The entire award was for the actual physical injuries she suffered and therefore would be excluded from gross income.
Wrongful Death Actions
Prior law continues to apply to punitive damages received in a wrongful death action if the applicable state law in effect on September 13, 1995 (the date the personal injury bill was first presented to the House Ways and Means Committee), provides or has been construed to provide by a court decision issued on or before that date - that only punitive damages may be awarded in a wrongful death action.
There are other tax-cutting strategies in addition to those mentioned here. If you would like assistance in selecting tax-saving strategies that make the most sense in your situation, contact us today!