Taxation of RI Injury Awards | Taxability of Personal Injury Awards and Settlements
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As awards for back wages are often connected with a personal injury that interfered with the employee taxpayer’s earning capacity, understanding the distinction between awards for back wages and their personal injury award counterparts is crucial. The key difference between awards for back wages and personal injury awards is that awards for back wages are subject to federal taxation, while personal injury awards are excluded from federal taxation.
Unless the injury is physical, any settlement or award is taxable. That makes awards for discrimination, emotional distress and/or injury fully taxable — even though these awards are intended only to make you whole again.
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For a verdict or settlement to be tax-free, it must be structured to meet two Internal Revenue Code requirements:
A physical injury or illness must have occurred. Without either, the proceeds will clearly be taxable.
The injury or illness must be the result of a tort — a wrongful act, injury or action. If you successfully sue someone who hit your car, the award will be tax-free. But if you win a back pay judgment from a breach of contract suit, the award is taxable income. It resulted from a contract dispute.
Neil Johnson
www.thetaxdude.com
taxdude@covad.net
IRS Code Section 104
Compensation for injuries or sickness
(a) In general except in the case of amounts attributable to (and not in excess
of) deductions allowed under section 213(relating to medical, etc., expenses)
for any prior taxable year, gross income does not include –
(1) amounts received under workmen’s compensation acts as
compensation for personal injuries or sickness;
(2) 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;
(3) amounts received through accident or health insurance (or through
an arrangement having the effect of accident or health insurance) for
personal injuries or sickness (other than amounts received by an
employee, to the extent such amounts (A) are attributable to
contributions by the employer which were not includible in the gross
income of the employee, or (B) are paid by the employer);
(4) amounts received as a pension, annuity, or similar allowance for
personal injuries or sickness resulting from active service in the armed
forces of any country or in the Coast and Geodetic Survey or the Public
Health Service, or as a disability annuity payable under the provisions
of section 808 of the Foreign Service Act of 1980; and
(5) amounts received by an individual as disability income attributable
to injuries incurred as a direct result of a violent attack which the
Secretary of State determines to be a terrorist attack and which
occurred while such individual was an employee of the United States
engaged in the performance of his official duties outside the United
States. For purposes of paragraph (3), in the case of an individual who
is, or has been, an employee within the meaning of section 401(c)(1)
(relating to self-employed individuals), contributions made on behalf of
such individual while he was such an employee to a trust described in
section 401(a) which is exempt from tax under section 501(a), or under
a plan described in section 403(a), shall, to the extent allowed as
deductions under section 404, be treated as contributions by the
employer which were not includible in the gross income of the
employee. For purposes of paragraph (2), emotional distress shall not
be treated as a physical injury or physical sickness. The preceding
sentence shall not apply to an amount of damages not in excess of the
amount paid for medical care (described in subparagraph (A) or (B) of
section 213(d)(1)) attributable to emotional distress.
(b) Termination of application of subsection (a)(4) in certain cases
(1) In general Subsection (a)(4) shall not apply in the case of any
individual who is not described in paragraph (2).
(2) Individuals to whom subsection (a)(4) continues to apply An
individual is described in this paragraph if –
(A) on or before September 24, 1975, he was entitled to receive
any amount described in subsection (a)(4),
(B) on September 24, 1975, he was a member of any organization
(or reserve component thereof) referred to in subsection (a)(4) or
under a binding written commitment to become such a member,
(C) he receives an amount described in subsection (a)(4) by
reason of a combat-related injury, or
(D) on application therefore, he would be entitled to receive
disability compensation from the Veterans’ Administration.
(3) Special rules for combat-related injuries For purposes of this
subsection, the term ”combat-related injury” means personal injury or
sickness –
(A) which is incurred –
(i) as a direct result of armed conflict,
(ii) while engaged in extra hazardous service, or
(iii) under conditions simulating war; or
(B) which is caused by an instrumentality of war. In the case of
an individual who is not described in subparagraph (A) or (B) of
paragraph (2), except as provided in paragraph (4), the only
amounts taken into account under subsection (a)(4) shall be the
amounts which he receives by reason of a combat-related injury.
(4) Amount excluded to be not less than veterans’ disability
compensation In the case of any individual described in paragraph (2),
the amounts excludable under subsection (a)(4) for any period with
respect to any individual shall not be less than the maximum amount
which such individual, on application therefor, would be entitled to
receive as disability compensation from the Veterans’ Administration.
(c) Application of prior law in certain cases The phrase ”(other than punitive
damages)” shall not apply to punitive damages awarded in a civil action –
(1) which is a wrongful death action, and
(2) with respect to which applicable State law (as in effect on
September 13, 1995 and without regard to any modification after such
date) provides, or has been construed to provide by a court of
competent jurisdiction pursuant to a decision issued on or before
September 13, 1995, that only punitive damages may be awarded in
such an action. This subsection shall cease to apply to any civil action
filed on or after the first date on which the applicable State law ceases
to provide (or is no longer construed to provide) the treatment
described in paragraph (2).
(d) Cross references
(1) For exclusion from employee’s gross income of employer
contributions to accident and health plans, see section 106.
(2) For exclusion of part of disability retirement pay from the application
of subsection (a)(4) of this section, see section 1403 of title 10, United
States Code (relating to career compensation laws).
Legal Notice per Rules of Professional Responsibility: The Rhode Island Supreme Court licenses all lawyers and attorneys in the general practice of law, but does not license or certify any lawyer / attorney as an expert or specialist in any field of practice. While this firm maintains joint responsibility, most cases of this type are referred to other attorneys for principle responsibility.
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