Compensation Payments Taxable

Compensation Payments Taxable? Find out whether a compensation settlement for personal injury incurs tax in the UK and how claims for lost income can be calculated taking tax into account

UK solicitor explains the different elements that make up a personal injury claim; answers the question “are compensation payments taxable” for pain and suffering and lost income awards; discusses how income and capital gains following receipt of your compensation settlement are treated differently than the original compensation payment and explains the need to contact a financial advisor so as to minimize any future tax liability you might have.

What are the compensation payments made in a personal injury claim?

A personal injury claim for compensation has primarily two parts:

  • Compensation payment for pain and suffering and loss of amenity (known as general damages); and
  • Compensation settlement for financial losses and expenses, including lost income (known as special damages).

The compensation payment you receive at the end of your claim is the combination of the general and special damages and is typically paid in full and final settlement of your claim.

Are compensation payments taxable in the UK?

The answer to the compensation payments taxable question is technically: “No”, but the amount of lost income you receive was already adjusted for tax.

Let me expand a little further on that answer.

“No” – because the sum you are awarded at the end of a personal injury claim is not in itself subject to tax and is therefore tax free.

Compensation Payments Taxable?

Compensation Payments Taxable?

However, if your claim included compensation for lost income, your solicitor could only claim a net payment for the lost income element. In other words – the compensation value for lost income is calculated as though you had already paid tax.

Lost income is calculated in this way for both past and future lost income.

The law in the UK does not permit a Claimant to be over compensated. In other words – to recover more in lost income than you would have received had you completed the work is not permitted.

For example – imagine you had 6 months off work when your claim settled and the medical expert in your claim predicted a further 10 years of inability to work. Both the 6 months and the future lost income (calculation discounted for early payment) are both valued net of tax.

Is money made from investing your compensation payments taxable?

“Yes” – be warned once you have received your personal injury settlement monies – any income or capital gain derived from these monies would be considered taxable in the same way as if you had invested your own earned money.

For example – if you deposited your compensation monies and received interest payments, the interest would have to be declared to Inland Revenue. If you invested in shares and made a capital gain – the gain too would also be considered available for taxation.

What should you do to minimize your tax liability on investing compensation payments you receive?

If the sum of compensation you receive is substantial – you should always seek financial advice as to how best to invest the monies so as to minimize the tax that you might pay on income or capital gains you derive.

Solicitors should never provide you directly with financial advice – but your solicitor might be able to put you in touch with an independent financial advisor before you receive payment of your monies. The financial advisor should be able to assist with not only investment options, but also discuss whether it is advantageous to hold the compensation money in the form of a trust.

Compensation Payments Taxable Summary

In this article you have seen how the different elements of your personal injury claim are treated differently due to tax when calculating the amount of compensation you should recover; the manner in which your final compensation payment is treated as tax free; how best to minimize any future compensation payments taxable liability from income or capital gains derived from your settlement award.