Do You Need to Claim an Insurance Lawsuit Award on Your Income Taxes?
- Insurance settlements wholly designed to compensate you for physical injuries you received as a result of another person's negligent act against you are generally considered indemnity payments and are not taxed. Indemnity means the process of making someone financially whole. If an insurance company compensates you for actual medical costs you incur, you do not profit from the settlement, and therefore the IRS does not consider the award as taxable income.
- Liability insurance includes coverage for physical injuries, but it also pays for other costs for which you are legally liable after an accident. If the liability settlement you receive includes money for other damages besides physical injuries, you may owe tax on the non-injury portion. For example, lost wage compensation is sometimes taxed because the money it is replacing, you normal income, would otherwise be taxed. Pain and suffering awards are also sometimes taxed.
- The law recognizes that you can be injured in ways other than bodily harm. Awards for non-tangible losses like discrimination and sexual harassment are called personal injury awards. Generally, unless you are compensated, at least in part, for a physical injury, the settlement money is fully taxed by the government. Even if a physical injury occurs, the award must be the result of a wrongful action, or tort, to qualify as tax exempt. An award stemming from a contract dispute, by contrast, is likely taxable.
- Generally, the person or company that awards money to another person is responsible for notifying the IRS that a financial transaction has occurred, if the award is in excess of $600 as of the time of this publication. This must happen even if the award is not taxable under current tax law. According to the law firm of Weitz and Luxemberg, the payor must also determine if the award is taxable. It is then the recipient's responsibility to list the money on his tax return accordingly.