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Can bad faith insurance settlements be taxed by the IRS?

When it comes to bad faith insurance settlements, many people in Jacksonville wonder whether these settlements can be taxed by the IRS. This can be a complex question to answer, due to the many variables involved in bad faith insurance litigation and other associated factors.

According to Forbes, physical injury is often a key component in whether a bad faith claim is considered taxable. In general, such claims on their own can be taxed by the IRS. However, when they are associated with personal injury claims, bad faith insurance settlements are typically not taxed (since personal injury settlements are also not taxable). This can also be a factor if the actions of the insurance company resulted in a worsening of a plaintiff’s physical condition (i.e. a failure to provide a settlement impeded the plaintiff from accessing the help he or she needed).

There are other situations where settlement amounts would be deemed taxable, no matter if they were linked to personal injury. In one case, a breach of contract suit with an auto insurer led to a settlement amount that exceeded the insured’s policy limitations. To this end, the IRS determined that the damages awarded up to $50,000 (the limit on the insured’s auto policy) were not taxable, while everything in excess of that amount was.

In another case, a denial of a long-term disability claim led to insured to file a bad faith suit. The insured was subsequently awarded the settlement, which he believed to be tax-free. Conversely, the IRS argued that when premiums are covered by the insured’s employer (as in this case), the settlement was able to be taxed. 

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