Tax season is around the corner. If you have a current claim or case pending for which you are seeking money damages as the result of injuries sustained due to the negligence of a third party, you should consider how a potential settlement or judgment may impact your income tax status.
Compensation awarded through settlements or judgments that represents damages on account of personal injury or sickness are not considered gross income and are therefore not taxable. See Internal Revenue Code, IRC §104(a)(2). Generally, medical expenses incurred, loss of normal life, or pain and suffering, is not considered taxable income. If your injury was physical, and the damages awarded for your injury stem from that physical injury, your compensation will not be considered taxable income. Other considerations must be taken where the injury claimed is not physical in nature.
If part of your settlement agreement contains a “confidentiality clause,” you should pause for concern. These clauses are considered “bargained-for-agreements” that are separate and distinct from the settlement agreement for the personal injury. Money offered in exchange for a confidentiality clause is considered taxable income. As an additional warning, if the parties who agree to the inclusion of a confidentiality clause do not set aside a specific amount of money in the agreement meant to be attributable for the clause, a Tax Court may be free to assign any “just or fair amount” as the amount exchanged for the clause, as held by the Court in the well known case when Dennis Rodman kicked a camera-man sitting too close to the court. In that case the parties settled for $200,000, and the settlement agreement contained a confidentiality clause. Liquidated damages for a breach of the clause were $200,000. The court believed the clause was a critical part of the agreement and assigned $80,000 to represent that portion attributable to the confidentiality clause.
For a more critical reading of that case, see: Amos v. Commissioner of Internal Revenue, T.C. Memo. Docket No. 13391-01, 2003-329, December 1, 2003.
–David H. Latarski
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