Q: Tax responsibility for insurance compensation?

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(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;

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The 5200 would be reported on Schedule C and subject to federal and social security tax.

But will there be followup medical appointments? If yes, then more of that $5200 is for medical purposes as well.

deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include?

personal injuries or sickness;

by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

$5200 is for medical purposes as well.

makes no difference how the amount of the settlement is computed. Look at your own quote: "(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;"

But the part for "loss of her income" is taxable (though I might quibble over the self-employment tax part if it's considered earned income).

Seth

No, it is not.

I don't know why, but this issue keeps popping up over and over again. The law means what it says. Settlement payments for physical injury are excluded from taxation. The only exception is if the payments are for punitive damages. There is no exception to the exclusion rule for payments based on lost wages.

Back to the OP. There is also no tax on the settlement used to cover medical expenses. However, the medical expenses covered by the medical portion of the settlement are not deductible.

My understanding was that it is.

Emotional distress damages are also expressly excluded. But looking at the wording of the statute, §104, one applicable subsection says that taxable income does not include,

"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;..."

"On account of personal injuries" means compensation specifically for those injuries. Lost wages is lost wages. It arises from the personal injuries, but is not compensation for the injuries per se.

___ Stu

*********BEGIN QUOTE*********** Rev. Rul. 85-97, 1985-2 CB 50,Internal Revenue Service, (Jan. 1, 1985) Section 104.--Compensation for Injuries or Sickness

26 CFR 1.104-1: Compensation for injuries or sickness.

Damages; personal injury settlement; lost wages.--

The entire amount received by an individual in settlement of a suit for personal injuries sustained in an accident, including the portion of the amount allocable to the claim for lost wages, is excludable from the individual?s gross income. Rev. Rul. 61-1 amplified.

ISSUE

Are amounts received by a taxpayer, under the circumstances described below, excludable from gross income as damages received on account of personal injuries?

FACTS

The taxpayer was seriously injured when struck by a bus. To recover for the injuries suffered as a result of the negligent operation of the bus, the taxpayer sued the bus company. The complaint alleged that, as a direct and proximate result of being struck by the bus, the taxpayer had sustained serious and permanent injuries, had been unable to pursue normal employment activities and had lost wages, had suffered and would continue to suffer great pain of body and mind, had sustained permanent disability, deformity, and loss of earning capacity, and had incurred and would incur in the future hospital, doctors? and related bills in an effort to be cured of these injuries. The complaint asked for compensatory damages of5x dollars. No punitive damages were requested. Prior to trial, the taxpayer and the bus company agreed to a settlement under the terms of which the taxpayer received a lump-sum payment of 3x dollars in exchange for a full release of all the taxpayer?s claims against the bus company. The taxpayer had not deducted any medical expenses in a prior year.

LAW AND ANALYSIS

Section 61 of the Internal Revenue Code provides, in part, that, except as otherwise provided in subtitle A, gross income means all income from whatever source derived.

Section 104(a)(2) of the Code excludes from gross income the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.

Section 1.104-1(c) of the Income Tax Regulations provides, in part, that the term ?damages received (whether by suit or agreement)? means an amount received (other than workmen?s compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.

Rev. Rul. 61-1, 1961-1 C. B. 14, holds that the entire amount received by a railroad employee in settlement of any and all claims that the employee had against the railroad for personal injuries is excludable from gross income under section 104(a)(2) of the Code. even though the employee elected to apportion part of the settlement amount to ?time lost? in order to receive railroad retirement credit for the time the employee was unable to work. The revenue ruling states that the fact that the ?time lost payments? constituted compensation for purposes of the taxes imposed by the Railroad Retirement Tax Act does not preclude the application of the exclusion from gross income under section 104(a) (2). Thus, the ruling indicates that the exclusion provided by section

104(a)(2) extends to personal injury damages allocable to lost wages. Also cf., Norfolk & Western Ry. Co. v. Liepelt, 444 U.S. 490 (1980) (defendant is entitled to an instruction to jury that damages for lost future wages are not subject to federal income taxation).

In the instant case, the entire 3x dollars settlement amount, including the amount allocable to the claim for lost wages, represents compensation for personal injuries sustained by the taxpayer when the taxpayer was struck by the bus. Therefore, the exclusion provided by section 104(a)(2) of the Code extends to the entire settlement amount.

HOLDING

The entire 3x dollars settlement amount is excludable from the taxpayer?s gross income under section 104(a)(2) of the Code and the regulations thereunder.

**********END QUOTE************ In particular read the 1st complete paragraph which begins, "The entire amount ..." and the Holding.

Many recent rulings have referred to Rev Rul 85-97 so it is still in force. For example, take a look at PLR 200041022 available at

By the way, even compensation for emotional distress is excluded if the distress is a result of the physical injury or illness.

My statements regarding exclusion of the insurance settlement have been based upon one important and unstated fact. Who was at fault in the accident? Besides being recieved for physical injury or illness, the payment must be based upon a tort or tort-like action.

If Nestor's friend was at fault, then only the $12,300 for medical expneses is excludible and then only if the friend hasn't deducted those costs on an income tax return. The rest is taxable.

If, on the other hand, someone else was at fault an the insurance payment is to settle that someone else's tort or tort like liability, then, except for any already deducted medical payments, the entire settlement is excluded from federal income taxation.

Thanks, Bill. I'm happy to learn that I had it wrong for all these years.

___ Stu

You're welcome, Stu. I'm just returning a favor you've done for me several times.

Regards, Bill

To all:

Thanks to everybody for responding. I forwarded your posts to my friends.