Settlement Income

[sea-tax]

Client gets in a car accident in 2005 and later sues the person who hit her and the insurance company.
In 2006 they reach a settlement out of court for $200k for compensatory damages pain and suffering.

As I understand it the settlement is tax free but the interest earned on the trust account is taxable. Correct?

Secondly because of the accident the taxpayer incurred some $85k of medical bills. the doctor filed a lien against the settlement which was eventually fulfilled in 2006 for $50k.
The Attorney for my client settles the lien and directly pays the doctor for the medical bills from the settlement funds and then gives my client what is left after attorney's fees.

Question: Do these medical bills (paid for from the settlement money which is not taxable due to it being pain and suffering), get to be able to be deducted on Sch A as a medical expense subject to 7.5%?

Thanks for any and all advice I rarely have these types of situations and they always seem to throw me for a loop.

[veritas]

As to the settlement

If the amount received is for a personal injury it is not taxable. Interest would be taxable.

Medical expenses- Good question

It talks about it sort of on page 4-8 in the ttb.

Code Sec 265 says no deductions related to tax-exempt income. Don't know if that applies here or not.

[Gene V]

Reading Pub. 502 page 23: Damages for Personal Injuries
I would say NO. I would copy and paste the paragraph, but every time I copy the paragraph, its want to copy both columns. Is there a way to just copy one column from a page?

[veritas]

See page 3-20 in TTB

for lawsuits and awards.

[sea-tax]

thanks guys, but...

Veritas I already read that section of the tax book and still I don't think it answers my question.


GeneV I read quickly what that pub said but I don't think it describes my clients situation. They got the settlement for just pain and suffering not for medical expenses. It just so happens that the accident caused medical expenses and the doctor liened the settlement to make sure that he got paid. Once the settlement was agreed the lawyer then sent a check from the settlement amount to the doctor to satisfy the lien he placed on the settlement. At no time did my client sue for medical expenses only pain and suffering.

The way I see it the settlement is not taxable and the interest on the settlement is taxable, we all agree on that?

Now how about the medical expenses? Sorry if I was not clear before this whole thing confused me a little.
Thanks for both your advice and anymore you have.

[veritas]

Well after doing a little reading

I would look at the settlement agreement to see if part was for medical expenses.

You know how clients can leave out little details and sometimes generalize.

[sea-tax]

I would look at the settlement agreement to see if part was for medical expenses.

You know how clients can leave out little details and sometimes generalize.

Thanks already spoke to the lawyer and he states that nothing in the agreement speaks of medical expenses, only pain and suffering and compensatory damages. He is forwarding me a copy in the next couple of days.

The way I kind of see it basically the client got 200k for pain and suffering and then chose to spend the money on medical expense which they incurred. If they had gotten the money from say wages they would be able to deduct these expenses.

The fact that the money came from a nontaxable settlement I am not sure disallows the deduction. This is the real question I guess. Does the fact that the client paid for medical bills from a nontaxable source of income disallow the medical deduction? Any thoughts?

[jimmcg]

If the settlement agreement itself stipulates that the compensation is for physical pain and suffering then as you say it is not taxable. How the proceeds were spent is at the discretiion of the taxpayer (even in light of the lien on settlement) and would be deductable. The receipt of the settlement proceeds and the spending of the settlement proceeds are two seperate events with two seperate tax consequences.

[veritas]

The claimant and the attorney

had to know there were going to be medical expenses. Their award says it is for pain and suffering, but can you imagine no discussion about the medical bills?

The question is could the IRS reallocate the settlement for medical expenses?

[jimmcg]

The question is could the IRS reallocate the settlement for medical expenses?[/QUOTE]

The Service can do anything they want however I would think it would be very dificult and time consuming to go against the actual wording of the legal instrument that gave rise to the taxable event. It might get written up at the audit level but I do not believe it would survive for the Service at the appelate level. In the interim I would certainly be an advocate for my client, structure a case on their behalf and proceed accordingly.

[veritas]

Maybe

In Niles v. United States, 710 F.2d 1391 (9th Cir. 1983), the court held that where no express allocation of a lump-sum personal injury award had been made to future medical expenses, the IRS may not so allocate any portion. In Rev. Rul. 79-427, 1979-2 C.B. 120, however, the IRS made an allocation to future medical expenses based on evidence presented at trial (and on appeal), even though the jury award did not allocate the amount awarded to any specific type of damages.

When it comes to taxes I gotta like the 9th circus court.

[sea-tax]

Thank you Jim, Veritas and Gene, you have all given me some food for thought. I appreciate all your oppinions.

At this point I am going to wait to see the actual document and if it is as the lawyer described then I will most likely proceed to deduct the expenses.


Does anyone else have anything to add?

[Bees Knees]

Reading Pub. 502 page 23: Damages for Personal Injuries
I would say NO. I would copy and paste the paragraph, but every time I copy the paragraph, its want to copy both columns. Is there a way to just copy one column from a page?

Hold down your Alt key and then draw a rectangle around the column you wish to copy.

[Gene V]

Thanks

Thanks Bees--it worked

Now I'm buying the new Web CD for sure.

Damages for Personal Injuries
If you receive an amount in settlement of a personal injury
suit, part of that award may be for medical expenses that
you deducted in an earlier year. If it is, you must include
that part in your income in the year you receive it to the
extent it reduced your taxable income in the earlier year.
See What If You Receive Insurance Reimbursement in a
Later Year, discussed earlier.
Example. You sued this year for injuries you suffered in
an accident last year. You sought $10,000 for your injuries
and did not itemize your damages. Last year, you paid
$500 for medical expenses for your injuries. You deducted
those expenses on last year’s tax return. This year you
settled your lawsuit for $2,000. Your settlement did not
itemize or allocate the damages. The $2,000 is first presumed
to be for the medical expenses that you deducted.
The $500 is includible in your income this year because the
entire $500 was allowed as a medical expense deduction
last year.
Future medical expenses. If you receive an amount in
settlement of a damage suit for personal injuries, part of
that award may be for future medical expenses. If it is, you
must reduce any future medical expenses for these injuries
until the amount you received has been completely used.
Example. You were injured in an accident. You sued
and sought a judgment of $50,000 for your injuries. You
settled the suit for $45,000. The settlement provided that
$10,000 of the $45,000 was for future medical expenses
Page 23

[Black Bart]

Beg your pardon, sea-tax, but aside from the

Client gets in a car accident...sues...her...insurance company...settlement...for $200k for compensatory damages pain and suffering.

As I understand it the settlement is tax free...Correct?

Schedule A med expense question, I'd like to be clear on what's tax-free.

I'm never quite sure about the non-taxability of these and they're usually such large amounts that it makes me nervous to tell somebody their award isn't taxable and to disregard it, while worrying that IRS might possibly come back on them (and me) later.

The ones I usually see are from car wrecks. They're mostly paid with a check giving no distribution detail at all (med/pain/punitive/whatever) and no 1099 is issued.

As I understand it:
Medical expense reimbursement is tax-free.
Pain and suffering is tax-free.
Punitive damages are taxable.

Is that correct?

If it is, what about when the check comes as described above (no distribution)? No doubt some is for medical expense (they have the doctor bills), but are you justified saying the rest is all for pain and suffering? Does IRS have any basis to maybe say some of it is taxable punitive damages?