If you are an Oklahoman receiving or getting ready to pay out a personal injury award or settlement, physical injuries are not taxable, but non-physical injuries are. But, what about those gray areas, like emotional distress injuries? Call OKC tax lawyer, Travis Watkins, to determine what portion of the award or settlement is taxable.

After my initial article came out concerning the taxable portions of lawsuit awards and settlements, I received a few calls by local personal injury lawyers.  They wanted to know if awards or settlements for injuries arising out of emotional distress are taxable.

This is an important question, and it will become more important over the next few months as the IRS has issued a new audit guide to its examiners to target under-reporting and under-payment of taxes from lawsuit awards and settlements. We expect that this means that more audits are on the way.

As discussed in my previous article, damages that arise out of physical injuries are not taxable.  Damages that arise of non-physical injuries are taxable.  But what about this gray area of damages known as emotional distress?  There are physical and non-physical aspects of emotional injury or sickness under Oklahoma law, and there are emotional components of many serious physical injuries.  So, are emotional damages taxable or not in Oklahoma?

The general rule is, an emotional distress recovery on account of (caused by) personal physical injuries or sickness is excludible, non-taxable income.  See IRC Sec. 104(a).  In Oklahoma, intentional infliction of emotional distress can be a stand alone intentional tort, not requiring physical injury.  Emotional distress can also be a mere component of a physical injury that just rides along as another special damage for a legal wrong committed by another.  The classic example is depression following an auto accident or a violation of the victim's employment rights.  Finally, there is an odd creature in Oklahoma law known as negligent infliction of emotional distress that is an independent cause of action which requires a) negligence on the part of the wrongdoer which causes emotional distress and b) physical injury.

There is little guidance on these issues in Oklahoma, but here is how I think it shakes out.  Non-taxable awards for emotional distress must have physical injury, as mentioned.  For that reason, emotional pain and suffering which relate to bodily injury (the classic auto case, above) are non-taxable.  However, an employment-based emotional damage component is taxable, since most of those cases do not involve bodily injury. 

Emotional distress is defined in a Conference Committee Report to the SBJPA, Public Law 104-188 as "includ[ing] physical symptoms, such as insomnia, headaches, and stomach disorders."  Not coincidentally, these are the same types of symptoms necessary to support a negligent infliction of emotional distress independent cause of action in Oklahoma.  So, those are non-taxable damages as well.

As mentioned, intentional (as opposed to negligent) infliction of emotional distress damages do not require physical, bodily injury in Oklahoma.  So, intentional infliction of emotional distress damages are taxable, ie. they cannot be excludible gross income. 

These are tough questions, if you are an injured person about to receive a lawsuit award or settlement, you cannot afford to get these questions wrong if you are ultimately audited.  Call me and schedule an appointment, so we can get it right.