How Are Personal Injury Settlements Paid Out in Florida?
Unsurprisingly, personal injury cases account for a high proportion of Florida civil litigation. An individual can file a personal injury case when harmed by the negligence or intentional action of another person, business, or government agency. The most prevalent examples include auto accidents, slips and falls, medical malpractice, and defective products.
To have a basis for a case, the defendant must have a duty of care. A duty of care is a legal obligation to take measures to protect others in certain situations. For example, all motorists have a duty of care while behind the wheel.
In addition, the plaintiff must prove that the defendant breached that duty of care, that the breach caused him harm, and that the damages relate to that harm.
When the plaintiff has clear and convincing evidence of these key elements, insurance companies tend to favor settling the case before trial. In addition, defending a personal injury claim through a trial and appeals often costs the insurer more than the claim’s value. Therefore, it makes economic sense for them to settle the case with minimal expense.
Also, when the potential damages are extensive, insurers are subject to the risk of being liable for a big verdict. Though they are willing to invest more in defending high-value cases, they tend to aim at negotiating a settlement that is lower than the likely jury award. Accordingly, most personal injury cases end in a settlement.
Many people wonder how insurance companies pay personal injury settlements.
Many are lump sum, though some are structured, where the defendant makes periodic payments for a specified period. The defendant delivers the settlement check to the plaintiff’s attorney, who deducts contingency fees and expenses the firm fronted on behalf of the client. Many settlements include documentation that breaks the payment into several components, such as a specific amount for medical bills, lost income, and pain and suffering. These breakdowns have tax implications that are important in negotiating the terms.
The Settlement Payment Process for Lump Sum Settlements in Florida
Once the parties agree to terms, a few steps remain before the plaintiff receives the money. Firstly, the parties sign an agreement detailing the settlement terms. Then the lawyers must draw up paperwork that each party must sign before finalizing the agreement. In some situations, lawyers may negotiate on some of the finer points of the language included in the documents.
Once the agreement is finalized and signed, the insurance company generally takes a few weeks to generate and send the check.
The Settlement Payment Process for Structured Settlements in Florida
Most personal injury cases settle for a lump sum. However, some situations call for structured settlements, where periodic partial payments are made according to a specified schedule. For example, the plaintiff may pay monthly, quarterly, or annual installments until the settlement is paid in full.
A structured settlement could be advantageous to the plaintiff by reducing taxes. Accepting a lump sum settlement often propels the plaintiff’s income into a much higher tax bracket, resulting in a tax bite that attenuates the settlement’s benefits.
For instance, imagine a plaintiff receiving a lump sum settlement that includes three years of lost income. Since lost income reimbursements are taxable, the plaintiff would be responsible for three years’ worth of income in one year, pushing him into a higher tax bracket. But a structured settlement over three years would keep the taxable income in its proper tax bracket.
A key part of settlement negotiations includes determining the appropriate compensation for different types of damages, such as medical expenses, lost income, and emotional distress. Your settlement agreement informs you of how a settlement is divided between the different categories. These breakdowns are key when you file taxes because some are taxable and others tax-exempt.
What Parts of a Settlement Are Taxable?
Most personal injury claims settle out of court, making taxability a key feature of settlement negotiations. When cases result in a jury verdict, the panel awards damages for specific harms according to its determination. For example, it may award $25,000 for medical bills, $50,000 for lost income, and $50,000 for pain and suffering.
The advantage of an out-of-court settlement is increased flexibility in allocating funds between taxable and non-taxable income. For instance, a larger portion allocated to emotional distress versus punitive damages has tax advantages because emotional distress payments are non-taxable, but punitive damages are taxable as ordinary income.
Personal Injury Settlement Tax Rules in Florida
The Internal Revenue Service (IRS) requires the insurance company to file 1099 showing your settlement amount. This allows the IRS to calculate your total income from the settlement and all other sources, then match it against your return.
Any discrepancies can result in an IRS audit. To prevent an audit, always report your income from the settlement according to the proper allocations between different damages categories. Hiring a professional can save you time and stress while providing audit protection if you are unskilled in tax return preparation.
Medical Expense Reimbursements Are Non-Taxable Unless You Deducted Them in Prior Years
The federal taxing authorities reason that personal injury victims should owe no income tax for the medical expenses portion of a settlement. Medical expenses are a cost that you are receiving reimbursement for rather than a source of income. Therefore, taxing this portion of a settlement as if it was earned income would be grossly unfair.
However, the IRS requires you to report medical expense settlement amounts as income if you deducted the same expenses previously. For instance, suppose you amassed $30,000 worth of medical bills after an accident and deducted $10,000 of those expenses from your taxable income that year. Then, the following year, you receive a settlement reimbursing you for $30,000 in injury-related medical costs. In that case, you must report the $10,000 you deducted as income on your return, though the other $20,000 would remain non-taxable.
Taxable Income and Wages in Florida
The IRS views settlement monies that reimburse you for lost income differently. Though the money comes from an insurance company rather than an employer or business revenue, the IRS treats it as ordinary income. Theoretically, this is money you would have been liable to pay taxes on had the accident not occurred, so it is unfair for you to avoid paying your fair share because you received your customary income from an insurance settlement.
Punitive Damages Are Taxable in Florida
Punitive damages rarely apply to personal injury settlements. Courts impose them to punish bad actors and deter others from engaging in similar conduct. As such, they have no application in cases where the injury resulted from an honest mistake. Accidents occur because of errors, such as not seeing another car on the road. The law regards punishing civil defendants for accidents as inimical to a just outcome.
Instead, courts find the parties at fault for accidents negligent and require them to make the victim whole through economic and non-economic damages.
When courts apply punitive damages, they do so on top of the usual economic and non-economic damages. For instance, suppose a trucking company broke hours of service and maintenance regulations, knowingly creating hazardous situations for other motorists. If a collision results from these intentional actions, a court may award punitive damages. The trucking company engaged in misconduct rather than negligence, and punitive damages help deter other companies from engaging in illegal and hazardous conduct.
What If You Are Audited After Reporting Settlement Income
The IRS more closely scrutinizes the income tax returns of taxpayers reporting large legal settlements. Often, there is a large increase in the income year over year because of the settlement, making time spent auditing the return more productive. Also, tax laws are filled with nuances that impact the reporting of legal settlement income, of which most taxpayers have limited knowledge. As a result, mistakes are frequent, making the returns suspect in the eyes of the IRS.
Many personal injury settlement recipients are better served by having their returns prepared by a tax professional.
For example, IRA contributions can result in an audit if your income that year surpasses eligibility requirements. Many taxpayers make this mistake when accustomed to a lower income bracket, and the settlement eliminates their eligibility for this tax benefit. Avoiding this issue can save you time, aggravation, and IRS penalties.
The issuance of a 1099 by the defendant can also trigger an audit. Many forms of income correspond to 1099s, including self-employment. Self-employment tax is double the payroll tax rate applied to W2 workers.
However, self-employment tax is inapplicable to settlement income related to lost wages, general damages, and punitive damages. An audit for this situation will require you to demonstrate the income did not come from self-employment to avoid the extra tax and penalties.
If you face an audit, understand that the IRS generally starts the process by proposing a reassessment of your tax that benefits it maximally. As a result, you must respond to the audit and request that any incorrect reassessments be taken off your account. Failure to do so leaves you liable for more than you owe.
The personal injury settlement payment process is generally completed within a few weeks. Time is needed to finalize the agreement and for the insurer to issue the check. Recipients face tax implications based on whether the settlement is lump-sum or structured and the allocation of funds to the various damages categories. Injury victims unfamiliar with tax preparation often need the assistance of a tax professional to avoid audits and maximize deductions.
Consult With Florida Personal Injury Lawyers
Rosen Injury law specializes in personal injury claims. Our litigation team has collected over $100 million for our clients. If you have suffered an injury, contact Rosen Injury Law for a consultation.
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