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 sicknesses 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 will 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.
Overall, when considering the sheer volume of claims of bad faith that many insurance companies face, there are relatively few tax cases that explore the tax status of bad faith recoveries. While some insurance lawyers report that they regularly see clients pay taxes on recoveries, others see clients exclude them from income with few disputes. Ultimately, the likelihood of whether a plaintiff’s recovery will be taxed is greatly influenced by the creativity and skill of the insnurance claim lawyer they choose to represent their case.
Treated Unfairly By an Insurance Company?
At The Morgan Law Group, our Miami 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. Get in touch with our office online to discuss your claim with our knowledgeable professionals today.