Taxation of a Personal Injury Award
The income tax law of the United States has a broad general rule in the notorious Section 61: gross income includes all income.
§ 61. Gross income defined.
(a) General definition. Except as otherwise provided in this subtitle, gross income means all income from whatever source derived … ” 26 United States Code [Internal Revenue Code] § 61
However, an electrical accident claim will generally be a personal injury claim. The good news is that personal injury claims are specifically excluded from federal income tax:
§ 104. Compensation for injuries or sickness.
(a) In general. Except [for] deductions allowed … 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 …
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) [26 USCS § 213(d)(1)]) attributable to emotional distress.” 26 United States Code [Internal Revenue Code] § 104
Under this law, the award for personal injury is not income, and not taxable, whether the award is from a settlement, or from a lawsuit. The words of the statute say that the recovery is not taxable: “… whether by suit or agreement …”
In electrical accident cases, a settlement may include a stream of payments, extending over the life of a seriously injured person, or perhaps to support his family for a number of years. This stream of payments is usually guaranteed by an insurance company, and is called a “structured settlement“. Under this statute, a structured settlement including the periodic payments, can result in a tax-free stream of payments for life. Even that part of the payments that could be regarded as interest (and therefore taxable) will still be tax free.
However, setting up a structured settlement must be done in compliance with the tax law. Most attorneys who handle the bigger cases and obtain structured settlements consult with a plaintiff-friendly structured settlement expert in formalizing such a settlement deal. The structured settlement expert will also be consulted to make sure that the payments are big enough. That is, the payments should include a reasonable increase because the insurance company gets to invest the money over a long time.
If the electrical accident resulted in death, family members will get the settlement. Since the damages are on account of personal physical injuries, resulting in death, the award to the family members is not taxable.
A settlement may create allocation issues. For example, was any of the settlement for lost wages, or was it all for personal physical injuries? For another example, most settlements are for a single amount as a release of all claims. Must some of the settlement be allocated to emotional distress? Discussion of these issues is beyond the scope of this article, and may depend on the facts of the specific case.
Oregon follows Federal law on Taxation of Personal Injury Settlements
Most states, including Oregon, follow the United States law and do not tax personal injury victims on the judgment or settlement proceeds.
Oregon Revised Statutes Section 316.007 “Policy. It is the intent of the Legislative Assembly, by the adoption of this chapter, insofar as possible, to:
(1) Make the Oregon personal income tax law identical in effect to the provisions of the [Federal tax law] Internal Revenue Code …
Section 316.012 Terms have same meaning as in federal laws; federal law references. Any term used in this chapter has the same meaning as when used in a comparable context in the laws of the United States relating to federal income taxes …”
No reported case has been found (as of July 2008) that applies the statutes quoted above. Nevertheless, the statutory wording is straightforward. Oregon state law follows the Internal Revenue Code definition. Personal injury settlements are not subject to the state income tax, with possible exceptions.
Structured settlements are commented on in an Oregon Department of Revenue document found online at http://www.oregon.gov/DOR/STATS/docs/ExpR07-09/Chapter1.pdf
“Individuals who are liable for damages to compensate for causing personal injury or sickness can make a payment to a settlement company rather than making a lump sum payment to the injured party. The settlement company invests in an annuity and then makes periodic payments to the injured party. This allows the responsible party to pay a smaller total settlement. The interest on the annuity or bond is not included in the taxable income of the settlement company. Likewise, the periodic annuity payments, which contain both principal and interest components, are not included in personal taxable income for the injured party [Compensatory Damages (1.010)].”
Electrical accident attorneys are usually experienced personal injury lawyers who are qualified to handle the larger cases. However, they do not also practice in the tax area. Clients are generally referred for tax issues to a tax attorney or certified public accountant. However, the foregoing discussion may be helpful as general information. Make sure to check with a tax adviser before agreeing to an injury settlement.