Taxability of damage compensation

Taxability of damage compensation

Do you have to pay taxes on your damage compensation?

Your personal injury case is coming to an end: the amount of your damage compensation has been determined and the next step is to sign a settlement agreement with the liable party. In this phase, many victims wonder whether tax must be paid on the amount to be received. In other words: do you as a victim still miss a part of your damage compensation because you have to hand it over to the Tax Authorities?

Damage compensation

The damage compensation that you receive usually consists of several components. For example, you can receive compensation for the extra costs you incur as a result of the accident. These costs cannot be considered as income, but form a compensation for costs that you have already incurred.

For the psychological suffering and grief that has been inflicted on you, you can receive immaterial damage compensation (pain and suffering). This compensation is not regarded as income and therefore also not taxed.

However, it is not certain whether there will be no tax on the compensation for a loss of income. After all, the compensation can be considered as profit. On the other hand, compensation for a loss of income is always a net amount, which should therefore remain tax-free. The Tax Authorities can, however, decide to tax the damage compensation afterwards.

Tax guarantee

A guarantee that no tax has to be paid on the damage compensation cannot be given. It is however possible to shift this risk to the liable party (read: the insurer). This can be done by including a so-called ‘tax guarantee’ in the settlement agreement. Through a tax guarantee, you can arrange with the insurer that any taxes levied by the Tax Authorities will not be your responsibility, but the responsibility of the insurer.

By having a tax guarantee included in your settlement agreement, you will thus prevent you from having to hand over a part of your damage compensation to the tax authorities. In this way, it is guaranteed that your damage is actually compensated.

It happens regularly that victims with personal injury have to hand over a part of their damage compensation to the Tax Authorities because tax is levied on the payment. A high personal injury compensation that is paid out in one go can also lead to a reduced right to benefits or a higher contribution for care, which means that victims actually have less of their personal injury compensation left than expected. For which damage items do these fiscal consequences apply and how can it be prevented that victims suffer indirect disadvantage as a result?

Written by mr. S. Demirci

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