Are Insurance Bad Faith Recoveries Taxable?

The complexities of insurance claims can be daunting, especially when an insurer fails to handle your claim fairly, potentially leading to a bad faith recovery scenario. As you seek restitution through legal channels, a new question emerges: Are bad faith insurance payments taxable? This pivotal query not only impacts your financial planning but also influences the approach toward managing your compensation.

Whether you’re recovering from personal injury or property damage, understanding your tax responsibilities is crucial in ensuring that you don’t encounter unexpected fiscal burdens following a successful insurance settlement. At The Morgan Law Group, our seasoned bad faith insurance claim attorneys will help in the intricacies of bad faith insurance claims, safeguarding your rightful compensations.

Bad Faith Insurance Claims in Personal Injuries

In personal injury claims, victims rely on insurance settlements to cover medical expenses, lost wages, and other damages. A bad faith insurance claim may arise when an insurance company unjustly denies a claim, delays payment, or underpays the damages rightfully owed to the insured.

• Refusal to Pay Claimed Medical Costs: Despite clear evidence and medical documentation, an insurance provider may refuse to compensate for the medical treatments related to the injury.
• Unreasonable Delays: Deliberately delaying the processing of claims to pressure the claimant into settling for a lower amount.
• Lack of Communication: Failing to provide timely updates or explanations regarding claim status or decisions.

Are There Taxes in Bad Faith Insurance Proceeds in Personal Injury?

If you recover a settlement for bad faith damages, is your recovery taxable? The answer is that it depends. One of the main deciding factors influencing whether or not a bad faith settlement is considered taxable income is whether the recovery is for physical injuries or sickness. In many cases, compensatory damages for bad faith claims related to injuries or illnesses are tax-free as long as the bad faith case relates back to the damages. While physical damages for personal injuries or illnesses are tax-free, damages for emotional distress or pain and suffering are subject to taxation.

Another key influence will be who paid the premiums on the insurance policy. Under Section 104(a)(3) of the tax code, amounts received through accident or health insurance for personal injuries or sickness are excludable for income – except if the insurance premiums were paid by the insured’s employer. In other words, if a person’s disability pay or settlement would have been taxable, their bad faith recovery would be too.

Yet another influencing factor is whether or not the recovered amount is within or in excess of the insured’s policy limits. As established in Watts v. Commissioner, bad faith settlements related to uninsured motorist claims may be considered tax-free up to the limits of the insured’s policy. Any excess recoveries that exceed policy limits are taxable.

Bad Faith Insurance in Property Damage Claims

Property damage claims involve compensation for damage to property, such as homes or vehicles, due to accidents, natural disasters, or other covered events. A bad faith claim may surface when an insurance company inadequately assesses the damage, offers a settlement far below the estimated repair costs, or unreasonably delays the claims process.

• Undervaluation of Damages: Offering an amount less than what is required to restore or replace the damaged property, ignoring estimates provided by independent assessors.
• Failure to Conduct a Proper Investigation: Not performing a thorough investigation into the claim or disregarding evidence of damage.
• Denying Coverage Unjustly: Wrongly asserting that the damage is not covered under the policy terms.

Are There Taxes in Bad Faith Insurance Proceeds in Property Damage Claims?

In property damage cases, insurance settlements are typically designed to make the insured financially whole again, compensating for the loss to bring their property back to the pre-damage condition. This principle guides the taxation rules concerning these settlements. 

Essentially, if the settlement amount solely replaces the loss, it is not taxable. This is because the payment is seen as a restoration of the insured’s property value rather than income generation or gain.

However, taxation can come into play under certain conditions. If the settlement results in a financial gain – meaning the payout exceeds the original cost or the depreciated value of the property at the time of loss – this excess might be considered taxable income. The “cost basis” of a property is essentially what the property owner initially paid for it, adjusted for factors like improvements or prior damage.

For example, consider a scenario where a property initially cost $100,000 and is insured for this amount. If it suffers damage and the fair market value at the time of the damage is $90,000, but the insurance settlement provides $100,000, the $10,000 excess over the current market value could potentially be subject to taxes. 

Treated Unfairly By an Insurance Company?

At The Morgan Law Group, our insurance lawyers have more than 25 years of combined experience protecting policyholders against the dishonest tactics of insurance companies. If your claim has been unfairly denied, delayed, or limited, our team of advocates can help you seek the just compensation you deserve. Call us today or complete our online form to schedule your free consultation to discuss your claim with our knowledgeable bad faith insurance claim attorneys.