The IRS has just issued new regulations for tax-free legal settlements related to personal injuries.
Effective immediately, recovery for an injury need not be based on tort law to be tax-free. Torts refer to civil violations that could be grounds for a lawsuit such as battery, negligence and other causes. The section 104(a)(2) exclusion from gross income for tax purposes has been expanded to include any amounts received on account of personal injuries or physical sickness.
While emotional distress is not considered a physical injury or physical sickness by itself, damages for emotional distress caused by a physical injury or physical sickness are excluded from income. An example is emotional pain and suffering as the result of an injury sustained in a car wreck.
According to an attorney from The Ashmore Law Firm, that’s good news for those who, under past laws, might have been taxed for such conditions as emotional distress, even if it was caused by a physical injury. As long as there is no economic gain to the injured party, the element of a settlement satisfies the requirement set forth in section 104(a)(2) and is considered a financial reimbursement to the taxpayer for his or her loss to return them to the position they were in before the injury.
We are not tax attorneys and do not give tax advice, so you will need to consult with a qualified tax professional on your particular situation. But the new regulations provide a bit more peace of mind for personal injury situations from a tax perspective.