A very common question from people who have a compensation claim from a personal injury (whether it is a work injury, car accident, public liability claim, National Injury Insurance Scheme or the like), is: do I have to pay tax on my settlement?
Towards the end of the financial year or just after, we sometimes get clients or their accountants raising a similar question: should I declare my personal injury settlement in my tax return?
The short answer to these questions is no.
Under the Income Tax Assessment Act, a personal injury compensation claim lump sum payment is not assessable income. What this means is that a ‘lump sum’ payment for a personal injury claim does not have to be declared in your tax return, because it is not taxable income.
It also means that you do not pay tax on any lump sum payment from a personal injury compensation claim. Such a payment is also not subject to payment of capital gains tax.
A ‘lump sum’ payment is where you receive an amount of compensation in one go, rather than periodically paid by the insurance company. Be mindful, that there is the option of agreeing to a periodic payment of compensation with an insurer, but it is best to get both legal and accounting advice before you do this, as it could change the taxation implications.
What about interest you earn from a lump sum amount?
Whilst the lump sum itself isn’t taxable, you must beware that if you invest any part of the lump sum or place it into an interest-bearing account – and you earn interest on the lump sum amount – then that interest will be considered taxable income and you will have to disclose this in your tax return and pay tax on it.
With interest rates rising, banks and institutions are competing for deposits from savers with high interest accounts and term deposits. For example, if you decide to put some or all your lump sum compensation in a term deposit account, then you will have to pay tax on any interest you earn on that lump sum.
Also, if you purchase an asset which is subject to capital gains tax, then you may be required to pay capital gains tax in later years when you sell that asset. For example, if you use your compensation lump sum to buy a house or shares, then you may have to pay capital gains tax if you decide to sell it later and you make a capital gain.
Can I put a personal injury settlement into Superannuation?
Using superannuation as a tax effective vehicle is something that is best discussed with a financial advisor and accountant. Importantly, there are some strict time limits within which any lump sum compensation amount from a personal injury claim mut be deposited into superannuation. It is best to get financial advice prior to any possible settlement negotiations in a personal injury claim, so that you are best prepared to manage the lump sum payment.
This is a brief overview of the tax treatment of a personal injury settlement. It is not a substituted for comprehensive financial or accounting advice. I recommend seeking good local financial or accounting advice so your individual circumstances can be considered.
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