Question

While jogging in July, Daniel was accidently struck by a delivery van and injured. After being hospitalized for 3 days, he was released – very bruised but with no permanent impairment. The driver of the van was arrested and ticketed by police for reckless operation of a vehicle and was later prosecuted for drug use. To avoid any adverse publicity of a lawsuit, the owner of the delivery service paid Daniel’s medical expenses of $5,000 directly to the hospital and sent him a $50,000 check on September 1, 2017. The check stated that “$50,000 is a settlement in full for physical injuries sustained.” Daniel accepted the settlement and cashed the check. He incurred no legal expenses relating to this settlement.

Question

How should Daniel treat the receipt of $ 50000 check and $ 5000 paid towards his medical expenses on his tax return?

Answer 1

The payment of $50,000 Daniel received as settlement in full for physical injuries sustained is federal-income-tax-free. It is not necessary that the settlement is a court-ordered award or an out-of-court settlement; as in the case of Daniel and it also done not matter that the settlement is paid in one go or in instalments.

It should also be noted that since 1996 the injuries sustained must be "physical." The IRS says that the injuries must be visible to be "physical." As before 1996 "personal" damages were tax-free, that included emotional distress, and many other legal injuries also produced tax-free recoveries. But in the case of Daniel he did sustain physical injuries as he was “very bruised”. Hence his settlement of $50,000 is tax-free.

The amount of $5,000 that Daniel received towards medical is tax-free too. However, if he claims a medical expense deduction for costs that are later reimbursed the same settlement, then he must “recapture” any amount that is specifically allocated to medical expense reimbursements up to the amount he has previously deducted on his tax returns. When there is no specific allocation to previously-deducted medical expenses, the award or settlement is automatically considered to be a reimbursement for such expenses up to the amount of those expenses. (IRS Revenue Ruling 75-230).