Recent Supreme Court Decision Will Likely Affect the Taxability of Personal Injury Settlements

Cozen O'Connor
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Cozen O'Connor

On March 4, 2019, the Supreme Court issued a decision in BNSF Railway Co. v. Loos, which ostensibly was limited to the Federal Employers’ Liability Act (FELA). However, FELA is incorporated by reference in the Jones Act, which governs claims of seamen for injury or death in service of a ship. In particular, the Supreme Court ruled on whether compensation for lost wages awarded in a personal injury lawsuit can be considered compensation for the purpose of federal income tax. By ruling that payment for lost wages is in fact taxable, the Supreme Court has potentially changed how lawyers and their clients will handle the settlements or judgments in personal injury lawsuits. In order to appreciate the significance of this decision, it is important to consider the IRS Code.

28 U.S.C. Sec. 104(a) states as follows:

(a) In general. Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include—

(1) amounts received under workmen’s compensation acts as compensation for personal injuries or sickness;

(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

. . . .

(emphasis added).

Based on the wording of 28 U.S.C. Sec. 104(a)(2), any settlement or judgment arising from a personal injury lawsuit has traditionally not been considered to be gross income or wages for income tax purposes. Generally speaking, this wording had been applied to any component of any recovery obtained by a personal injury plaintiff, other than punitive damages, irrespective of whether it applies to lost wages, pain and suffering, or some other category of damages.

In this case, the Supreme Court examined the wording of the FELA and concluded that any damages for lost wages qualify as taxable compensation. As such, the Supreme Court reversed and remanded this case for proceedings consistent with this new interpretation. Given this decision, the effects of income tax on awards will now play a major role in the calculation of damages in any personal injury action governed by the FELA, including, but not limited to personal injury actions governed by the Jones Act.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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