How Diagnostic Imaging Could One Day Affect Tax Laws for Personal Injury Settlements

How Diagnostic Imaging Could One Day Affect Tax Laws for Personal Injury Settlements


With the 2017 passing of the Tax Cuts and Jobs Act, IRS tax policy on personal injury cases is back in the spotlight. At the same time, for the past few years, the legal profession has been absorbing the impact of ever-more detailed imaging studies that, some argue, display a physical basis for certain neurological phenomena, including disorders like PTSD and subjective experiences like pain itself.


Strangely, these two seemingly unrelated forces — tax laws for personal injury cases and the use of advanced imaging technologies in the courtroom — could combine to affect the take-home damages that plaintiffs receive from a successful lawsuit. Here’s how, in a point-by-point analysis:


  • Tax laws for compensatory damages are complex, even circular. According to the IRS, damages paid out for physical injuries are tax-free. Damages for emotional injury, however, are fully taxable.


  • As researchers uncover more about the complex unity of physical and emotional systems in the human experience, courts and the IRS are faced with a challenge. Emotional trauma often leads to physical symptoms. Likewise, bodily injuries often result in emotional side effects. The two are difficult to separate. So which set of compensatory damages can legally go tax-free?  


  • Under current precedent, the IRS holds that taxability is associated with the principal injury. Cascading effects are lumped in with the root complaint. So if a defendant physically injures or sickens the plaintiff, compensatory damages awarded in the case are tax-free, even if some of those damages are paid out for emotional effects associated with the injury. Conversely, if the defendant’s negligence leads to emotional harm, and that psychological trauma manifests in physical symptoms, damages are fully taxable, even if some portion is awarded in compensation for bodily sickness arising from emotional distress.  


  • The Tax Cuts and Jobs Act raises the stakes on this issue of taxation. Plaintiffs who hire contingent-fee attorneys are now responsible for paying taxes on 100 percent of case-related payments — including that portion that goes to pay the lawyer. Under previous law, attorneys and plaintiffs each assumed their share of the tax liability associated with taxable payments resulting from the same case.


  • Here’s where advanced imaging could change the landscape. In 2008, the Arizona Superior Court in Pima County heard a landmark case, Koch v. Western Emulsions, Inc. The court allowed evidence of chronic neuropathic pain obtained with an fMRI scan, which the plaintiff’s expert witness said showed a clear physical pattern of brain activity “proving” the existence of the pain. Ultimately, the defendant settled for $800,000, more than 10 times their initial offering.


  • Since Koch, the scientific community has warned against using advanced imaging as a sort of “painometer.” The science just isn’t there yet, and there are ethical issues involved in imposing “mind-reading” technologies on plaintiffs, researchers say.


  • But brain scans are showing physical changes associated with a lot more than pain. In one study, MRI scans showed changes in the physical structure of the hippocampus in  Vietnam veterans with PTSD. Some had an 8 percent reduction in volume of the right hippocampus.


The question this all leads us to, then, is where to draw the line between physical and psychological injury. Advanced imaging technologies will continue to show greater levels of detail in the troubled brain. At some point, the courts and the IRS will have to wade into one of the most philosophically murky questions of all time: the mind-body problem. More to the point: Is there any injury, psychological or otherwise, that cannot be described as physical?


The answers we come up with will have dramatic effects on the value of settlements, damages, and tax payments in the years to come.