Will I have to pay tax on my injury compensation award?

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Injured people do not usually have to pay tax on personal injury compensation. There are some exceptions, however. This article explains the tax situation for personal injury claimants.

Claimants do not pay tax on injury compensation

If you receive financial compensation following an injury, specific legislation ensures that you do not have to pay tax on it. This is the case whether a compensation settlement is received as a lump sum or in staggered payments.

Whether the compensation is awarded by the court, or as an out-of-court settlement, you will be exempt from paying tax.

So why the confusion?

In 2014, HMRC revised its rules so that certain types of compensation became taxable.

Press reports suggesting that claimants have to pay tax on certain types of compensation created anxiety for people pursuing an injury claim. Many claimants were concerned that compensation calculated to meet treatment costs could be depleted after tax deductions.

The main focus of the reports in the media was compensation paid out for mis-sold payment protection insurance (PPI) on credit cards, loans, and other lending products. Successful claimants who received compensation for lost interest, in addition to the original PPI premiums, would have to pay tax on the interest component of their compensation.

As no tax was deducted at source, claimants would have to declare the compensation for lost interest as income on their tax returns.

Will interest received on my personal injury compensation be taxable?

Interest may be added to your compensation award. Interest would be calculated from the date of your accident or injury to the date of settlement of your claim.

In most cases, tax will be deducted by the party (usually the defendant or their insurance company) paying the interest. Even if the tax is deducted before you receive the payment, you will still have to declare it to HMRC.

For example:

A claimant sustained an injury on 1 January 2013 and their claim settled on 14 July 2014.

An award of £20,650 was made, comprising of £20,000 for damages and £650 for interest lost between 1 January 2013 and 14 July 2014.

In this example, income tax would be payable on the £650 as the interest represents the amount that the claimant would have accrued had the £20,000 been paid on the day of the injury up until the date of settlement.

Some tax on interest may be payable if payment is further delayed.

Even though a claim has been settled and an amount awarded, there may still be delays before you receive your compensation being paid to the claimant.

Any interest that the payer adds to the compensation because of a delay in payment is taxable because the interest is likely to be paid gross (no tax deducted). It should, therefore, be declared on any tax return.

For example;

A claimant was awarded £20,650 on 14 July 2014, but the payment was not made until 14 January 2015.

In this case, a further £206.50 was added to represent the six months' interest. The £206.50 is the amount to declare on the tax return.

What if I invest my compensation award and earn interest on it?

If you invest your damages award, any interest generated would be liable for tax. This is usually taxed at source for basic rate taxpayers but would need to be declared on a self-assessment return or to HMRC.

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Howard Willis, Personal injury solicitor

Author:
Howard Willis, Personal injury solicitor