Does a Person Have to Pay Income Tax on Money Received From a Medical Malpractice Settlement?

By: Jodee Redmond | Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance | Updated March 12, 2019

If you’ve read or heard about someone receiving a certain amount of money from a medical malpractice settlement, you may be wondering whether the injured person gets to keep the balance of the funds once they pay their attorney fees. Taxation of damage awards and settlement payments does happen, and the question of whether certain money is tax-free or not depends on how it’s allocated to the injured person.

Tip

Whether or not income tax must be paid on a medical settlement depends on how these funds are allocated to the aggrieved party.

Damages that May be Awarded in a Personal Injury Lawsuit

Before we start discussing whether a lawsuit settlement is taxable, it would be helpful to understand the different types of damages that can be awarded by a court in this type of case. Medical malpractice is a specific type of personal injury, where a patient was injured due to a doctor, dentist or other medical professional or hospital’s negligence. This negligence must result in significant damages, such as:

  • Disability
  • Loss of income
  • Medical bills (past and ongoing/future)
  • Unusual levels of pain and hardship

In determining how to compensate someone who has been affected by medical malpractice, the court can award different types of damages.

General damages are used to compensate the person for losses like pain and suffering and emotional distress as the result of the medical malpractice. When determining a monetary amount to compensate someone for general damages, factors such as the types of medical treatments required and the length of time the person needed to undergo treatment to recover from the injury would be taken into account.

Special damages are ones that the injured person can measure in terms of an economic loss. They are usually awarded to compensate injured people for things like lost earnings and medical bills.

Punitive Damages in a Personal Injury Lawsuit

In a situation where the negligence that resulted in harm to the injured person was so heinous that the court wants to punish the person, company or organization involved, punitive damages may be awarded. These damages are used as a warning to the defendant in the personal injury lawsuit, and they are also meant as a deterrent to others.

Personal Injury Medical Settlement Tax Treatment

Under changes to the tax law which take effect for 2018, damages received from a medical malpractice suit may be taxable, depending on the way they are categorized.

  • General damages paid to compensate a person for physical pain and suffering are tax-free.
  • Any amount paid to compensate someone for “emotional distress” is taxable.
  • Punitive damages are considered taxable.
  • If the injured person receives a certain figure representing interest owing on the amount payable, this amount is taxable.

According to the Internal Revenue Service (IRS), symptoms such as headaches, stomach aches and insomnia are considered to be normal physical reactions to emotional distress. As a result, any money received to compensate for these symptoms is taxable.

Medical Settlement Tax Deduction for Legal Fees in 2018 and Beyond

In 2018 and going forward, no deduction is available for legal fees paid for a medical malpractice settlement. For income tax purposes, it doesn’t matter if the person has signed an agreement that a certain amount of the settlement goes directly to the attorney on a contingency basis. The client still pays income tax on the full amount of the settlement.

A person who has been injured due to medical malpractice has many factors to consider. Along with consulting an experienced personal injury attorney, it’s a good idea to speak with a financial expert who can provide information and advice about the taxation of damage awards and settlement payments.

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About the Author

Jodee Redmond is a freelance writer, blogger and editor who has been working full-time in this capacity for over 15 years. She is a graduate of Centennial College and has worked as a tax consultant and a legal assistant. Her previous experience and boundless curiosity is a distinct advantage when writing about such varied topics as income tax, insurance, commercial property, business, construction, addiction, freelance writing and more.

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