If you’ve been a victim in auto accident which resulted in medical problems for you such as broken bones, most likely you had to miss work and handle significant suffering and associated pain. You need to go through visits to physicians, imaging studies, physical therapy, typical nightmares, mental counseling, and all in all it ends up being an extremely stressful time in your life.

At some point your case will settle and all of your damages will get reduced to a money figure. Are you then required to pay taxes on that figure? It actually depends on whether or not the settlement received is due to the injuries or for the loss of economic benefit.

The premise is that basically if the monies are being received for the injury then it is not taxable. if however the money received is for loss of economic benefit than it is included in gross income and subject to taxation. If you are out of work and lost wages and part of your injury settlement replaces those amounts, you would have to pay taxes on that because you would’ve been otherwise working and paying taxes anyway. There has been some precedents with case law as to this, put it is not always clearly defined. This article also is not being written by an attorney so this does not constitute definitive legal advice!

The IRS tax code has a section dealing with certain payments for physical personal injuries and their exclusion from gross income. That is Section 104. It is not clear cut as the IRS does not provide clear guidance on the terms “physical injuries or physical sickness”. If the compensation is received for “physical injuries or physical sickness” then that amount is excluded from gross income.

An IRS case in the past known as LTR 200041022 involved in IRS ruling about a woman who got a settlement from her employer as it related to unwanted physical contact. Since the settlement that the woman received was not based on actual physical injuries and there was no “observable bodily harm”, the IRS ruled that the settlement monies had to be included in her gross income.

There was also a United States Supreme Court case section 104, Schleier v. Commissioner. there was a two-step mandate that was adopted by the court with the cause of action need to be a tort type action with the monies received being on account of personal physical injury or sickness.

Since it is not clearly defined, individuals in this situation should talk to a competent tax lawyer to clarify exactly what should be included in gross income or excluded. Since settlements at times end up in the millions of dollars, this should be a definite prerequisite since if calculated incorrectly the IRS may get involved.

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