Is compensation taxable?

If you’re considering bringing a compensation claim for any reason, it’s only natural for your thoughts to turn to how much of your payout you’ll get to keep.

Regardless of whether you’ve been a victim of pension mis-selling, have been injured in a car accident, or want to claim compensation for any other reason, the first thing to say is you should 100% aim to get whatever you deserve.

Whether your compensation payment will be subject to tax depends on:

  • Why you’ve been awarded compensation
  • Your financial position

We’ll now give a general overview of when your compensation award might be liable for tax. However, whether you owe tax on your compensation will always depend on the particulars of your claim and your circumstances. If you need clarification on whether you need to pay tax on your compensation award, speak to your solicitor, claims management company, accountant or HMRC.

Is personal injury compensation taxable?

If you claim personal injury compensation following a road traffic accident or another incident, your compensation award will not usually be subject to income or capital gains tax.

Even additional elements of your claim, like compensation for loss of income, typically won’t be subject to tax. This is because a personal injury solicitor would claim loss of earnings based on your net income rather than your salary before tax.

Is pension mis-selling compensation taxable?

Just like pension mis-selling cases can be complex, so is the question of whether your compensation award is taxable.

In most cases of pension mis-selling, particularly those involving pension transfers, the point of compensation is to put you back in the position you would have been in had you not acted upon unsuitable advice.

According to the Financial Ombudsman Service (FOS) website, if you get your pension mis-selling compensation by way of a top-up payment into your pension, then you usually won’t need to pay income tax. This is because any payment will consider whatever tax relief you would have been or still are entitled to.

However, your pension mis-selling compensation may be paid directly to you. This could change the tax status of your payment, but you should speak to an accountant or HMRC to confirm.

Is compensation for other types of financial mis-selling taxable?

As with pension mis-selling, it’s complicated.

If you’ve been mis-sold another financial product, like an investment, then whether you need to pay tax on your compensation award can depend on if you still have the investment or asset. If you no longer hold the investment or asset, then the tax status of your compensation can depend on when you disposed of or sold it and the other circumstances behind this action.

The FOS suggests speaking to HMRC to understand your position if you receive compensation for a mis-sold investment.

For other types of financial mis-selling, like payment protection insurance mis-selling, you will usually only need to pay income tax on any interest paid as part of your compensation award. You typically won’t need to pay income or capital gains tax on the lump sum itself.

What if I need to pay tax on my compensation?

How you pay any tax liabilities on a compensation award depends on several factors, including:

  • Your circumstances
  • What the compensation is for
  • Who awarded you the compensation

For example, if the FOS awards you compensation, including interest, the business paying you the settlement should deduct income tax at the basic rate before paying you. They must pay the tax to HMRC and issue you a tax deduction certificate, but you may need to ask for this.

As all deductions will be made using the basic tax rate, your circumstances may mean you need to claim the tax back from HMRC, contact HMRC about your compensation award, or declare it on your self-assessment tax return so you can pay any further liabilities.

Don’t worry about tax and get the compensation you deserve

While some compensation awards may be taxable, you’ll still end up with a significant sum of money should you bring a successful claim for pension mis-selling, personal injury or anything else. In many cases, you won’t even have to pay the tax due yourself, as it’ll be deducted from your payment before it is sent to you.

If you’ve been mis-sold a pension or another financial product or suffered an injury that wasn’t your fault, LawPlus Solicitors can help you get the compensation you deserve.

Contact us here for a free, no-obligation review of your potential claim.

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