Tax implications on personal injury compensation

Tax implications on personal injury compensation

Injuries caused by someone’s behaviour or actions can impact the victim financially, physically, and emotionally.
The losses can be minimised after a settlement. However, some worry about how much of their reward they get to keep and how much tax they must pay.
Others even put off making a claim because they’re not confident they’ll receive any money back. While it’s true that not every claim goes to court and wins, it’s worth giving it a try.

You don’t have to pay any tax on personal injury compensation and only need to keep a decent amount to pay your lawyer the success fee to cover the costs of working and winning your case.
You don’t pay anything to your legal advisor; if they take your case, it means they believe in its potential to be successful.
If they accept it but do not win it, you won’t pay them anything, just like you don’t pay any tax on your attempts or settlements.

The legislation states that you don’t have to pay any tax on your award, whether you receive a few payments over a period or a lump sum, unless you’re self-employed, in which case there are some exceptions.

Understanding the two types of injury compensation (damages)

As you already know, you might be eligible to claim compensation if you’re injured in an accident caused by someone else.
You could be compensated if you’re implicated in an accident at work, a road traffic accident, a data breach, or other examples.
If you win your claim, the settlement amount you receive is typically based on two categories of damages – special or general.
Both are exempt from tax, so you don’t worry about paying anything else besides your claim solicitor’s success fee.

Let’s understand the differences between general and special damages to know what to expect following a claim solicitation.

General damages – What they are and how they are calculated

General damages are awarded to compensate the claimant for the loss of amenity that can be linked to the defendant’s behaviour or actions, or the direct physical and/or psychological effects of an accident.
Loss of amenity reflects how your injuries have impacted your lifestyle and means that there’s a financial value put on your hobbies, leisure activities, or other things you used to enjoy until the accident.
Your solicitor will try to verify that your claim has the grounds to proceed before agreeing to take it on.
To do this, they’ll need to know if the defendant owed you a duty of care and whether they breached it, as well as details about the injuries.
Evidence is necessary to substantiate your answers and can come in various forms, so check to find out more about it.

Besides the evidence, you will need to prove how your lifestyle was before in order to claim compensation for loss of amenity.

General damages are calculated based on the suffering and pain experienced from the illness or personal injury.
They’re easier to calculate than special damages and take into consideration the part of the body injured and the severity.
But if you’re calculating them using an online compensation calculator, remember that the amount you might receive can vary from your result because each claim is unique.
Usually, a medical assessment supports your case and ensures you’re compensated fairly.
This involves having your injuries assessed by an independent medical expert and being provided with a prognosis.

Special damages – What they are and how they are calculated

Special damages are rewarded for helping return you financially to where you were before the accident.
This means they aim to compensate for your out-of-pocket expenses that resulted from the defendant’s behaviour or actions.

Calculating special damages for future actual or potential losses can be complicated, as there are many factors to consider.
Shortly put, they could cover the following:
  • Repair or replacement of damaged property
  • Short-term and long-term medical expenses
  • Loss of earnings or earning capacity
  • Home/vehicle adaptions
  • Transportation costs
  • Care costs.

The largest part of any personal injury claim is the loss of earnings. It’s crucial to get this calculation right if your injury impacts your earnings.
It may be a good idea to reach out to a legal advisor to see if your case has the grounds to proceed and whether your costs might be recouped.
To help prove your expenditures, keep receipts and invoices.

Tax on personal injury compensation

There’s often confusion surrounding personal injury claims and tax, which keeps many victims from trying to claim compensation.
As a general rule, the legislation ensures you don’t have to pay any tax on your injury compensation, regardless of how you’re being reimbursed for the financial expenditures resulting from the injury.
No capital gains tax is charged on it.
It’s also irrelevant whether your case was settled in or out of court; your compensation is still exempt from tax. The following elements of compensation are all exempt from tax:
  • Compensation for personal injuries received as periodic payments or as a single lump
  • Compensation from an out-of-court settlement with the defendant
  • Interim payments paid in the absence of a final compensation award
  • Interest on compensation from the date of damage until the day of settlement or court verdict.

The general confusion may come from the fact that in 2014, HMRC revised its rules to make several types of compensation taxable.

When general damages aren’t exempt from tax

Tax laws are complex, and sometimes you must pay income tax on general damages, but it depends on what the reimbursement covers.
Let’s assume you receive damages to compensate for your lost earnings.
This amount aims to help you get back on track financially as if the accident never happened.
Therefore, you don’t pay income tax if the damages are equal to your net pay.

But if you’re self-employed and have missed out on a freelance job and claimed compensation to cover the loss of income, it’s a different case, as you’d probably receive general gross damages.
In this case, you’ll have to declare it on your tax return, as the HMRC would treat it as taxable income.

Investing the compensation and earning interest

You can choose to invest your compensation award, but the interest generated is liable for tax.
For basic rate taxpayers, this is usually taxed at source and should be declared to HMRC or on a self-assessment tax return.

One way to invest your compensation is to put it in a high-interest savings account.
The interest must be declared and might be taxable.

A taxable case
Your compensation award may include interest. It is calculated from the date of your injury/accident to the date of your claim’s settlement.
Most of the time, it’s deducted by the party paying the interest (usually the defendant or their insurance company).
However, you still have to declare it to HMRC even if the tax is deducted before receiving the payment.