It’s Tax Day – April 15 – Do you know if your Personal Injury Award is Taxable in Florida?

It’s TAX DAY! April 15th! Do I Need to Pay Taxes on My Personal Injury Settlement in Florida??

The short answer is "No, most of the time, you do not have to pay taxes on a personal injury settlement; but double check with the person who prepares your taxes."

The long answer is: It depends.

If the settlement or recovery was just for the injuries and medical bills, then you do not have to pay income tax. But, if the settlement or recovery includes an amount for reimbursement of lost wages or ability to earn income, then the answer is probably yes on that portion of the recovery.

The purpose of tort law (personal injury law) is to make someone whole again after they are injured, most often, the remedy is monetary in the form of a lump sum settlement or a jury verdict. While I am not a tax lawyer, a principle in tax law is that money paid to make someone whole again is not considered income and therefore is not taxed. A personal injury settlement is theoretically returning the person to the place they were before the accident – and since the person can’t always be completely healed, money is awarded for non-economic damages such as pain and suffering and mental anguish as well as for reimbursement for past medical bills and payment for future medical bills. An award or settlement which compensates a personal injury victim for their medical bills and pain and suffering is not considered income since it is putting the person back to the place they would have been but for the accident.

The Internal Revenue Code (IRC)

addresses personal injury settlements and awards in IRC section 104(a)(2) which states that personal injury awards or settlements are excluded from a person’s taxable income so long as the award or settlement is for a physical injury that resulted from an accident.

IRS Bulletin 2009-42 states:

"This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) to reflect amendments made to section 104(a)(2) of the Internal Revenue Code (Code) by section 1605(a) and (b) of the Small Business Job Protection Act of 1996, Public Law 104-188, (110 Stat. 1838 (the 1996 Act)), and to delete the "tort or tort type rights" test under §1.104-1(c) of the Income Tax Regulations.

As amended, section 104(a)(2) excludes from gross income 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. These proposed regulations conform the regulations to these statutory amendments and clarify the changes for taxpayers and practitioners. Section 1605(a) of the 1996 Act amended section 104(a)(2) to provide expressly that punitive damages do not qualify for the income exclusion. The amendment was a response to divergent court opinions, some holding that punitive damages are received "on account of" a personal injury. See H.R. Conf. Rept. 104-737 (1996) at 301. The amendment is consistent with O’Gilvie v. United States, 519 U.S. 79 (1996), holding that punitive damages are not compensation for personal injuries and do not satisfy the "on account of" test under section 104(a)(2). Section 1605(a) also amended section 104(a)(2) to provide that the income exclusion generally is limited to amounts received on account of personal "physical" injuries or "physical" sickness. Section 1605(b) of the 1996 Act further amended section 104(a) to provide that, for purposes of section 104(a)(2), even though emotional distress is not considered a physical injury or a physical sickness, damages not in excess of the amount paid for "medical care" (described in section 213(d)(1)(A) or (B)) for emotional distress are excluded from income. The proposed regulations reflect these statutory amendments. The proposed regulations also provide that a taxpayer may exclude damages received for emotional distress "attributable" to a physical injury or physical sickness. See H.R. Conf. Rept. 104-737 (1996) at 301.

The Tort Type Rights Test

: The proposed regulations also eliminate the requirement that "personal injuries or sickness" be "based upon tort or tort type rights." That requirement in §1.104-1(c) was intended to ensure that only damages compensating for torts and similar personal injuries qualify for exclusion under section 104(a)(2). In United States v. Burke, 504 U.S. 229 (1992), the Supreme Court interpreted the tort type rights test as limiting the section 104(a)(2) exclusion to damages for personal injuries for which the full range of tort-type remedies is available. The Court held that section 104(a)(2) did not apply to an award of back pay under the pre-1991 version of Title VII of the 1964 Civil Rights Act because the damages awarded under the statute provided only a narrow remedy and thus did not compensate for a tort type injury. The Burke interpretation precluded section 104(a)(2) treatment for similar personal injuries redressed by "no-fault" statutes that do not provide traditional tort-type remedies. Many critics thought the Burke remedies test was too restrictive. Later legislative and judicial developments eliminated the need to base the section 104(a)(2) exclusion on tort and remedies concepts. First, Commissioner v. Schleier, 515 U.S. 323 (1995), interpreted the statutory "on account of" test as excluding only damages directly linked to "personal" injuries or sickness. Second, the 1996 Act restricts the exclusion to damages for "personal physical" injuries or "physical sickness." Accordingly, under the proposed regulations, damages for physical injuries may qualify for the section 104(a)(2) exclusion even though the injury giving rise to the damages is not defined as a tort under state or common law. Nor does the section 104(a)(2) exclusion depend on the scope of remedies available under state or common law. In effect, the regulations reverse the result in Burke by allowing the exclusion for damages awarded under no-fault statutes."

 

One more question: If I have a claim for future lost income or loss of earning capacity, how are the damages calculated?

This matters because it determines how much of your income is considered in calculating an appropriate settlement or in the calculation of the jury’s award. Future lost wages or income and future loss of earning capacity damages are calculated by figuring out how much you would have been able to make in the future if you hadn’t been injured in the accident. Then there are calculations to reduce that amount to present day value, usually in a trial situation, there is an economist who crunches all of these numbers and makes charts and reports. But to make those reports, the economist needs to know whether to use before (gross income) or after tax future income. Obviously the numbers will be higher if the before tax income is used.

In Florida, if you want to convince the economist, the jury, the claims adjuster, the judge – or whoever you are trying to persuade to use gross income instead of after tax income, here is a brief history on the case law in Florida dealing with this issue. For a greater explanation of these cases, please see S. Moxon’s article Untangling Taxes from Personal Injury Damages – http://www.floridabar.org/DIVCOM/JN/JNJournal01.nsf/c0d731e03de9828d852574580042ae7a/82991b884d88fe7c852575c5004c3c80!OpenDocument&Highlight=0,disability ) :

1. Poirier v. Shireman, 129 So. 2d 439 (Fla. 2d DCA 1961), the court held that the trial court could instruct the jury that its award would not be taxable and it approved the following instruction: "You are instructed that any award made to plaintiff as damages in this case, if any award is made, is not subject to federal or state income taxes, and you should not consider such taxes in fixing the amount of any award made plaintiff, if any you make."

2. Stager v. Florida East Coast Railway, 163 So. 2d 15 (Fla. 3d DCA 1964), the 3rd DCA followed Poirier by holding that it was ok to give the same instruction to use non taxed income to calculate damages.

3. Atlantic Coast Line Railroad v. Braz, 182 So. 2d 491, 495 (Fla. 3d DCA 1966), 196 So. 2d 109 (Fla. 1967), the 3rd DCA held that it was also ok not to give the instruction and was silent on how the jury should calculate damages for lost income.

4. St. John’s River Terminal Co. v. Vaden 190 So. 2d 40 (Fla. 1st DCA 1966): the 1st DCA held that gross income should be used to determine how much to award for lost earning capacity and said "the award of damages should be based upon the plaintiff’s gross earnings or earning capacity and should not be reduced because of any income tax saving which may result to the plaintiff because of the fact that the damages will be exempt from income tax."

5. Good Samaritan Hospital Association, Inc. v. Saylor, 495 So. 2d 782, 783 (Fla. 4th DCA 1986), the 4th DCA followed St. John’s River Terminal Co., quoting the 1st DCA’s opinion above with approval.

6. Leaseco, Inc. v. Bartlett, 257 So. 2d 629 (Fla. 4th DCA 1971), applied and approved St. Johns River Terminal Co.’s gross income calculation for personal injury damages and it established a principle of law that personal injury damages awarded for lost earning capacity shall be calculated on the basis of gross income rather than after-tax

income.7. Basel v. McFarland & Sons, Inc., 815 So. 2d 687 (Fla. 5th DCA 2002): The 5th DCA skirted around the issue of pre or post tax calculation of future lost income, but ultimately didn’t say anything definitive about whether the jury’s award should be based on gross earnings or after-tax earnings.

Bottom line? It’s a little blurry, but, overall, the courts seem to say that the trial courts have discretion about whether to tell the jury to base future income on pre or post income tax earnings, but they generally hold in favor of having the jury base the injured party’s award on gross income (before taxes) which means the award would be high than post-tax future income.

What about my PIP benefits for lost wages – are they paid or post income tax?

The Florida PIP statute, F.S. §627.736 states that the lost wages benefits payable under a PIP policy include disability benefits, which cover "60% of any loss of gross income and loss of earning capacity per individual from inability to work proximately caused by injury sustained by the injured person . . . ." PIP pays 60% for wages and 80% for medical bills because the 60% payment of wages takes into account the tax savings of about 20% resulting from the fact that disability benefits are not taxable; ie an injured person would have had to pay income tax on wages if they were working and hadn’t had the accident, but since they are getting their lost wages from PIP after an accident, the amount of the payment is reduced to reflect that they didn’t have to pay taxes on the money. Sort of like 6 of one / half dozen of another – same difference. But the important take-away in the Florida Statutes? "The Florida Statutes confirm that the general rule in Florida is that damages for lost earnings and lost earning capacity are calculated on the basis of gross income." (Moxon) .

If you have been in an accident in Florida, consult with a lawyer. Most personal injury attorneys will provide a free consultation and will answer simple questions for you free of charge. If you have been awarded a personal injury settlement or verdict and you are filling out your fax forms – the award is probably not taxable – but its best to check with a personal injury attorney and an accountant on this issue.

Happy April 15th Everyone.

Kathryn 

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