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I need to understand the federal income tax liability for a

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personal-injury settlement. The settlement is...
I need to understand the federal income tax liability for a personal-injury settlement. The settlement is the result of a work-related, motor vehicle accident that happened while I was on a business trip overseas.

As as result of my injuries, I received temporary-total workers comp disability payments, as well as social security disability and medicare. Comp disability stopped at the time of the settlement.

The settlement breaks down as follows: 10% for physical pain & suffering. 30% for loss of past & future earnings. 60% for cost of future medical care, i.e. surgeries, palliative care and prescriptions.

All workers comp disability and medical costs, as well as foreign medical costs and medicare expenses were repaid from the settlement total.

Legal fees were actual cost, not based on contingency, and included all costs incurred by foreign attorneys as well as the principal and interest on several legal-aid fund loans taken on my behalf. Legal fees amount to approximately 25% of the settlement total.

Per custom, there was a subsequent, separate negotiation for recovery of the cost of legal fees. The defendant ended up reimbursing me for about 85% of my foreign legal costs.

Any information about liabilities for this type of settlement will be greatly appreciated.
Submitted: 6 years ago.Category: Tax
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12/1/2010
Tax Professional: CGCPA, CPA replied 6 years ago
CGCPA
CGCPA, CPA
Category: Tax
Satisfied Customers: 3,820
Experience: over 40 years experience in tax matters
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Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

 

The tax ramifications are as follows:

Disability - not taxable

Social Security Disability and Medicare - A portion of the Social Security may be taxable depending on your other income and filing status. There is no way to calculate this until your tax return is prepared. The rest in not taxable.

Pain and suffering - not taxable.

Legal fees will be deductible in the relationship they have as a percentage of taxable settlement.

Lost of earnings - Taxable as this is income you would have earned had the injuries not been incurred.

 

If you need additional assistance, please feel free to ask. I do recommend that, at least for this year, your tax returns be prepared by a qualified tax professional. Those fees will be tax deductible in the year you pay them.

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Customer reply replied 6 years ago
Thank you.

I know the tax issues regarding disability and social security income. I am unclear as to what you mean by the taxable nature of the legal costs as a percentage of the total taxable amount of the settlement. Would you clarify this, please.

Also, can you please confirm that the taxable amount of the settlement, i.e. the loss of income, is based upon the terms of the settlement agreement.

Thank you again.
Tax Professional: CGCPA, CPA replied 6 years ago

The legal fees portion that is deductible is a relationship of total legal fees to settlement amounts. For example if the settlement was for $100, taxable portion was $30, and legal fees $20 The deductible legal fees would be (30/100=.3X20= 6.667) $7 after rounding. I use 100 as the basis for the example so it will be simple for you to plug in your own numbers.

 

Yes, the taxable amount of the settlement ( the loss of income portion) IS based upon the amount of the settlement.

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