Monday, October 31, 2011

Taxing Insurance Settlements

A friend I’ll call Sam is in a situation that is new to me. He was in a car accident some time ago and has been trying to claim medical costs from an insurance company. The insurance company ignored him for a long time and recently offered a settlement that would close the matter. The problem is that the settlement appears to be taxable.

Sam has already paid $1200 so far in medical costs. The insurance company has offered to pay $1500 to settle the matter, leaving Sam to pay any remaining medical costs on his own. Sam is inclined to accept the offer rather than fight any longer, but the settlement documentation claims that the $1500 would be taxable to Sam. At a 46% income tax rate, Sam would only get to keep $810 of the settlement which is less than the $1200 he has already paid.

My first thought was to go back to the insurance company and ask them to cover his expenses so far ($1200) and pay an additional $300 lump sum to settle all other costs including any future costs. The hope here is that Sam would then only have to pay income taxes on $300 instead of $1200.

Are there any readers out there who are knowledgeable on these matters who would care to comment? Perhaps the Blunt Bean Counter has an opinion?

4 comments:

  1. Better to get a professional tax expert, but in the meantime:

    He most likely won't have to pay tax so long as the award qualifies as "special" or "general damages" for personal injury or death. Out of pocket medical would be special, and pain and suffering would be general (there are more than just those for each).

    So long as that is the case, the settlement will be EXcluded from income.

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  2. @Preet: Thanks. Upon looking at the settlement language again, it doesn't exactly say that the settlement would be taxable to Sam, but that it might be. So maybe this is just some weasel wording to cover themselves as opposed to an actual assertion about whether the money would be taxable.

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  3. The Blunt Bean CounterOctober 31, 2011 at 10:33 AM

    Michael, unfortunately this is a complicated area and I cannot proivde a simple answer without reviewing the actual situation.

    Preet has brought up an applicable provision of the Act. Here is a blog link on this topic.

    http://ottawalawyersconnection.com/2011/06/01/taxation-of-damages-what-a-difference-it-can-make/

    Sorry, I cannot provide you a quick answer

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  4. @Mark: I think Sam's situation is simple enough that he can figure this out from the information in the link you provided. Thanks very much.

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