In Victoria, you are generally not required to pay tax from lump sum compensation you receive from a personal injury claim. However, compensation payouts can still have important tax implications which you should be aware of.
Why don’t you have to pay tax on compensation payouts?
- Some parts of your compensation don’t relate to your loss of income or earnings. For instance, pain and suffering is payable for your loss of enjoyment of life, and is not considered income.
- Where your claim for compensation involves past or future lost income or earnings, the amounts payable are calculated based on your net losses; that is, your ‘take home’ pay, after tax. This means that the taxable component of your lost income has already been excluded from the claim.
There are a couple of important exceptions to this rule
- Where compensation is paid to you as a weekly benefit.
For instance, PAYG tax is withheld from weekly Loss of Earnings payments under the TAC scheme. This means that at the end of the financial year the ATO will be holding tax on your income support. So, when you lodge your tax return, the ATO will be aware that tax has already been withheld for those payments.
- Withdrawal of lump sum benefits from a Superannuation fund can result in tax being withheld.
If you have suffered injury or illness which is likely to prevent you from returning to work, you may be entitled to pursue a claim for “Total Permanent Disability”.
Obtaining this benefit does not require you to prove the fault of another and is separate to any compensation you may receive from, for example, a WorkCover claim or TAC claim. The payout does not come from your super contributions. Instead it is paid from an insurance product which commonly sits inside your superannuation fund.
The rules surrounding the tax payable from any withdrawal of a TPD benefit can be complex and depends on your circumstances and the superannuation policy type. It is important to get financial advice about the tax implications of withdrawing any money from superannuation – including a TPD benefit.
So, are there any tax implications for compensation payouts?
Even though tax is generally not payable from your personal injury compensation payout, there are still very important things to consider regarding how you invest any compensation and how that may affect your tax liabilities.
For instance, as a general principle, if you receive $100,000 in compensation and put it into your bank account, the compensation itself would not be taxable income but the interest you earn on that money is likely to be.
Further, there are rules about tax breaks, time limits and exemptions for people looking to invest their compensation payout into super.
Seeking financial advice is crucial
It is very important that anyone who is likely to receive a lump sum compensation payout speaks to a financial advisor to get advice about the most tax-effective way to invest compensation which needs to last a lifetime.
At Polaris, we don’t pretend to be experts about anything but personal injury law and compensation claims, but we take a whole person approach to you and your circumstances.
As a result, we always advise our clients to get advice from financial advice experts about how to invest their compensation. We can also provide the names of financial advisors who are experts in their field.