Several times a year clients ask whether a monetary recovery for an injury or death is taxable. The short answer is no, but there are exceptions.

It’s hard enough being injured, and then having to bring a lawsuit to obtain proper compensation and payments for your injuries. It would add insult to injury if you had to pay taxes on that compensation. One of the few things the government has done right about taxes has been to recognize that injury settlements are not earned income. Rather, they compensate the injured victim for the pain, suffering, and disabilities they suffered at the hands of another’s carelessness. Therefore, injury recoveries are not taxable.

Section 104(a)(2) of the Internal Revenue Code excludes from gross income amounts received from personal injury awards. It provides that gross income does not include any damages received, whether by suit or agreement and whether as lump sums or as periodic payments, on account of personal injury or sickness.

While this tax exclusion is about as old as the federal income tax system, it has caused much controversy in the courts and some clear exceptions have emerged since this provision was enacted back in 1918.

For example, money paid for punitive damages is taxable. The reasoning is that punitive damages are primarily intended to punish and discourage the behavior of the defendant, not to compensate the plaintiff. Lost earnings are also taxable if a portion of the settlement is specifically designated as compensation for lost income. Finally, money paid for psychological injuries may be taxed.

However, it is important to understand that once settlement proceeds have been received, the taxability of that money is just like any other money you invest or put in a savings account. When you invest those monies into taxable investments, then any profit or gain you achieve is then taxable.

What what does NBA star Dennis Rodman, with all his lurid tattoos and piercings, have to do with personal injury tax law?

Back in 1997, Rodman was playing for the Chicago Bulls in a game against the Minnesota Timberwolves. After scrambling for a loose ball, Rodman fell into a group of photographers on the sidelines. While getting up, he kicked a cameraman, Eugene Amos, in the groin.  Amos sought treatment for groin and back injuries, filed a police report, and hired a lawyer for a personal injury claims against Rodman. Before suit was filed, the attorneys for Amos and Rodman negotiated a $200,000 settlement agreement, which included a Confidentiality Provision stating that Amos had to keep the nature and amount of the settlement secret.

As mentioned above, the tax exclusion for a personal injury settlement has caused much controversy in the courts. It is fitting, then, that an act from an individual as unique and controversial as Dennis Rodman led to a unique landmark tax law case, Amos v. Commissioner, 2003 Tax Ct. Memo LEXIS 330 (2003), which created law allowing the IRS to tax Personal Injury settlements which include Confidentiality Provisions.

Relying on well-settled law that personal injury settlements were not taxable, Amos did not claim the $200,000 as part of his gross income on his 1997 tax return. But the ever-vigilant IRS took the position that he should have claimed the money as income because his injuries were minimal and the money was really paid for the confidentiality provision.

At the end of the case, the court determined that the $200,000 settlement had to be allocated between the amount paid for the personal injuries, which was exempt from taxation, and the amount paid for the Confidentiality Provision, which was taxable. Ultimately, the court arbitrarily allocated $120,000 to the personal injuries and $80,000 to the Confidentiality Provision.

Because confidentiality provisions can lead to tax consequences in personal injury cases, you need to be aware and seek out competent counsel to help prevent the government from getting money that should be in your bank account.

In light of the Rodman case, lawyers often stipulate at the time of settlement to allocate a nominal amount as the value of a confidentiality agreement.

Each situation is unique and this article is not intended to constitute tax advice for any person’s individual situation. The information contained in this article is provided for informational purposes only. You should consult a tax attorney or an accountant if you need help with your taxes or for questions about taxable income.

Ken Shigley  is author of Georgia Law of Torts: Trial Preparation & Practice and president-elect of the State Bar of Georgia.   A Certified Civil Trial Advocate of the National Board of Trial Advocacy, he has been listed as a "Super Lawyer" (Atlanta Magazine), among the "Legal Elite" (Georgia Trend Magazine), and in the Bar Register of Preeminent Lawyers (Martindale). He practices law at the Atlanta law firm of Chambers, Aholt & Rickard, and has broad experience in catastrophic personal injury, wrongful death, products liability,  spinal cord injury, brain injury and burn injury cases.

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