Non-Taxable Personal Injury Awards May Require an Enrolled Agent

Non-Taxable Personal Injury Awards May Require an Enrolled Agent

Taxpayers obtaining a personal injury award should seek professional advice about the tax consequences. An enrolled agent can not only explain when such awards are not taxable but can also defend this tax treatment with the Internal Revenue Service.

The rules studied for the enrolled agent exam address the types of income that are excluded from tax. One of the exclusions pertains to personal injury lawsuit settlement payments. The general rule in such cases is that money paid as reimbursement for property damage or medical bills is not taxable income. That’s because it is used to offset a loss.

Money paid for “pain and suffering” is also normally considered a compensatory award for a loss. Personal injury lawsuits usually include some payment that compensates for loss plus other types of amounts. The distinctive tax treatments are covered in enrolled agent CPE.

Money paid in a lawsuit for lost wages is clearly subject to income tax. These payments are a substitute for taxable earnings a taxpayer would have received. A personal injury award indicated as payment for psychological injuries seems to fall within this category of taxable income. A court case was decided in which money paid for psychological injuries is taxable as a form of lost wages.

The most common description for personal injury awards found in an EA continuing education course is amounts paid for punitive damages. The tax code was amended in 1996 to specifically classify punitive damages as taxable income regardless of any connection to an injury or illness.

Money awarded by a verdict after trail states how much of the award is for property damage, medical bills, lost wages, pain and suffering, and punitive damages. The jury verdict therefore determines the taxable effect of the personal injury lawsuit.

But payments relating to a settlement before trial are trickier. These do not necessarily specify the applicable award categories for the determined amount. However, the IRS may determine the tax impact by examining various documents related to the lawsuit. Fortunately, a properly worded settlement release eliminates guessing about an IRS determination.

Therefore, advice from enrolled agents is extremely valuable to individuals settling personal injury lawsuits.

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.