This article is the second of two parts of our series on the taxability of personal injury and medical malpractice settlements and verdicts for residents of New York State. We hope that you enjoy reading it, and invite you to contact us with any questions you may have by calling (718) 354-8000 today.
The General Theory: Personal Injury and Medical Malpractice Settlements and Judgments are Not Income and Thus are Not Taxable.
When a person suffers a serious injury, they experience a loss that is referred to as “damages” under the personal injury laws. This loss, in a personal injury lawsuit, is categorized into different elements, which can include pain and suffering, lost wages (both past and future), medical bills (both past and future), as well as other categories of damages that may arise depending upon the circumstances of the particular case. When a jury awards damages to an injured plaintiff in a personal injury lawsuit, the jury is, essentially, giving the plaintiff money to compensate them for what they have lost due to having been injured. This concept is the same when a personal injury plaintiff receives a settlement for the damages they have incurred.
As most every income taxpayer knows, the only amounts of money that are taxable under both State and Federal tax laws are those that are considered “income”. Generally, in very simple terms, income means “profit” (revenue minus expenses), and only profits are taxable. Because a personal injury award is only compensation for something that the injured person has lost, it is not considered “income”. The whole idea of a personal injury lawsuit is to seek compensation for what an injured person has lost (to make them whole after an injury), and so whatever money is awarded or received in an accident lawsuit is not considered income because none of it is profit. It is simply repayment of money that a negligent defendant took away from the plaintiff when they caused the plaintiff’s injuries.
How Does the Federal Tax Code Treat Personal Injury and Medical Malpractice Recoveries?
Under Section 104(a)(2) of the United States Tax Code, any money received as compensation in a personal injury or medical malpractice lawsuit (whether by a jury verdict or settlement) is not taxable as “income” under the income tax laws. This very important law specifically addresses both verdicts and settlements, and states that, unless punitive damages are awarded, you do not have to declare any money that you receive in a personal injury or medical malpractice lawsuit as income on your federal tax returns. However, because there are certain exclusions to this exemption, you should always consult with your lawyers, as well as an accountant, before making a final determination regarding whether or not and how, in your particular case, this important rule applies.
Usually, in personal injury and medical malpractice lawsuits, punitive damages are not awarded, but only “compensatory” damages, which are specifically excluded from taxability under this rule. Thus, in the vast majority of personal injury and medical malpractice cases, no tax will be owed. We advise, however, that you not spend too much of any money that you are awarded in a settlement or verdict before speaking to a tax professional and receiving a final and definitive answer on this particular issue.
How Does the New York State Tax Code Treat Personal Injury and Medical Malpractice Recoveries?
Thankfully, the New York State rule is essentially identical to the Federal rule regarding the taxability of any money received in a settlement or verdict in a personal injury or medical malpractice case. Of course, you should always consult with your lawyer and a tax professional before spending any of the money that you may receive in such a case to ensure that the particulars of your case do not raise any tax liabilities (no two cases are identical, so you should always consult with a tax professional to be safe).
What if I Want to Purchase an Annuity to Receive Future Periodic Payments, Rather than Receive My Money All at Once?
In personal injury and medical malpractice cases involving extremely substantial amounts of money, or where the plaintiff is a child or a person with mental disabilities, purchasing an annuity contract with the settlement proceeds is often advisable. An “annuity” contract refers to an arrangement whereby a plaintiff makes a deal with an insurance company whereby the plaintiff pays over the lump sum of his or her settlement or verdict award to the insurance company in exchange for a stream of future periodic payments, the sum total of which amount to far more than the original lump sum awarded in the plaintiff’s personal injury or medical malpractice case. After all, when an award is in the multiple millions of dollars, usually a plaintiff does not need all of the money in a lump sum, and is best served by setting up a stream of income that will last their entire lifetime.
Under the Federal and New York State tax laws, even though these annuity payments ultimately result in more money being ultimately given to the plaintiff than the value of their settlement or verdict, if the annuity is handled correctly, the plaintiff will not have to pay income tax on the annuity payments, even though they are receiving a “profit” above and beyond what they would have received from the settlement or verdict alone. It is important to know that, if a plaintiff receives settlement or verdict funds in a lump sum, and then, after taking possession of those funds, goes out and invests those funds, any profits made will be taxable. However, if the plaintiff does not take possession of the funds, but arranges to have the settlement or verdict funds deposited directly into an annuity as part of the settlement, or by court order (as in the case of a verdict), the payout from the annuity is not taxable.
Call Us Today for a Free Consultation Regarding the Taxability of Your Settlement or Verdict
Our Bronx personal injury and medical malpractice lawyers deal with these issues every day, and offer free consultations on these and any other issues related to personal injury and medical malpractice lawsuits when you call us today at (718) 354-8000.