Are Compensatory or Punitive Damages Taxable? - Stoy Law Group, PLLC. (2022)

When it comes time for taxes, reportable income can vary. If you received money from a court settlement, you are probably wondering if you are required to report your earnings.

The term “damages” applies to the amount of money the victim receives due to the lawsuit. Courts promote justice for those involved by awarding damages. Justice is given to those suffering who receive a lump sum to help them through the situation they are experiencing financially.

Justice also administered as a punishment for those acting negligently and creating an incentive for others not to engage in similar behavior.

There are two types of damages that result from lawsuits:

  • Compensatory
  • Punitive

In a lawsuit, the defendant is the party charged, while the plaintiff is the one pressing charges. Any damages awarded go to the plaintiff.

So where does the law stand on money received as a court settlement?

Are lawsuit settlements considered as taxable income?

Before we can answer that question, let’s look at the different types of damages and why a judge or jury would award them.

Compensatory Damages vs Punitive Damages

People have disagreements that are usually resolved between those involved without any additional help.

Sometimes though, further guidance is needed.

When an event reaches the courts to make a decision, the result is to discover if the defendant must pay the plaintiff, how much, and why. The next question is if the financial exchange is taxable.

But first, the types of damages you may receive.

(Video) How to Win Higher Punitive Damages

What Are Compensatory Damages?

Compensatory damages deal with the actual loss backed up by evidence.

Just as the name implies, it is compensation for injuries accrued due to the actions of the defendant to the plaintiff. This reparation is intended to help the plaintiff with any expenses they had to take care of themselves.

Primary reasons for compensatory damages include:

  • Physical injury
  • Medical expenses
  • Emotional distress
  • A decrease in quality of life
  • Property damage
  • Lost wages

Compensatory damages get broken into two categories:

  • Economic
  • Non-economic.

Economic damages involve compensation for monetary costs: bills for medical expenses, property damage that requires fixing or replacement, and income lost because of missed work due to the events surrounding the lawsuit.

Non-economic damages involve pain and suffering, emotional distress, and a decrease in quality of life-related to the events involved with the court settlement.

Let us look at a real-life situation, such as a car accident.

The plaintiff is taking the defendant to court because Person B (defendant) crashed into Person A (plaintiff). Due to the vehicles colliding, Person A suffered a shoulder injury. Person A had multiple visits to the doctor and was unable to work for a period of time directly related to the injury.

All the injuries listed would fall under economic damages. If Person A reports a loss of enjoyment of life-related to the shoulder injury, then non-economic damages are claimed.

With the help from a car accident lawyer, the judge agrees that the actions of Person B personally affected Person A. Person B must now reimburse Person A for the medical bills and money that Person A would have received via paycheck for any employment hours missed. Person A would also receive an amount that was decided as the value for the decrease in quality of life.

Are Compensatory or Punitive Damages Taxable? - Stoy Law Group, PLLC. (1)

What Are Punitive Damages?

Punitive damages aren’t awarded to balance any loss the plaintiff has experienced.

(Video) Definition: Compensatory Damages

Instead, these damages are designed to be a form of punishment for those found responsible by the lawsuit. Typically, punitive damages get reserved for situations where the defendant acted with extreme recklessness and no regard for the safety of the plaintiff.

Your personal injury attorney knows if punitive damages are a possibility depending on your situation.

In the auto accident scenario, the plaintiff may pursue punitive damages if the defendant was under the influence of alcohol or drugs at the time of the car crash. The defendant’s actions intentionally put others at risk and may have increased the physical damage done to people and property involved.

Damages in this category can be controversial because they are in addition to any compensatory damages that get paid.

The punishment is intended to discourage any further behavior that is similar to the actions reviewed in the lawsuit. It’s a way of ensuring justice for victims of situations that were out of their control.

Damages awarded as punitive are not common, as clear evidence must prove the defendant acted willfully malicious and was immensely irresponsible in their actions.

Are Lawsuit Settlements Taxable Income?

If you received a court settlement in the past year, is it considered taxable income? To answer that, the type of awarded sum and the initial reason for granting must consider.

Are Punitive Damages Taxable?

Punitive damages are a very cut and dry situation. Because punitive damages are not to compensate for any loss, be it economical or emotional, they are taxable under all conditions.

The IRS requires any punitive damages to be reported as “Other Income” when filing for taxes.

So the short answer is:

Yes, punitive damages are considered as taxable income.

Any money Person A received that was part of the punitive damages would be considered separate from the compensatory damages, and the punitive money is taxable income.

(Video) Jury Awards Jason MILLIONS in Malicious False Advertising & RICO Case

Compensatory damages are not as black and white.

Are Compensatory Damages Taxable?

The type of compensatory damage – economic or non-economic – does not affect the taxability of the award.

Instead, taxability on compensatory damages depends on the reasons for awarding the money. Physical injury and emotional injury play an essential role in the decision.

Physical Injury

Personal injury cases, like the car accident example, awarded damages for physical injuries are not considered taxable income and do not need to be reported.

The definition of “physical injuries” is a crucial point here.

Physical injuries involved in a personal injury must be considered visible by the IRS to avoid taxation. Cuts, scrapes, bruises, broken bones and other visible injuries mean the income is not taxable with no requirement to report.

Looking back at our example above with the car wreck with Person A and Person B.

If there is money awarded to Person A because of the broken shoulder and multiple cuts, Person A does not need to report the money. Person A keeps the tax-free cash. Tax-free only pertains to the funds given explicitly for the physical injuries viewable on Person A.

Any additional damages awarded must follow the taxable regulations specific to them.

However, if damages are awarded and non-visible injuries are involved, the IRS usually requires a portion of the money.

Examples of non-visible injuries are sexual harassment, slander, or defamation. Emotional distress is different from non-visible injuries but handled similarly.

Emotional Injury

When it comes to damages awarded for emotional distress, there are two varieties. If compensatory damages given for emotional distress that shows physical symptoms, the IRS finds the money taxable.

(Video) What Is Tortious Interference With Inheritance Rights? | RMO Lawyers

In this case, a person reports having headaches caused by stress. The headaches are a physical symptom caused by emotional distress. Therefore, any compensation received will need to be disclosed and taxed as income.

However, if a bodily injury has caused emotional distress, it is treated as a physical injury in a personal case and any damages awarded are not taxed.

These situations can be tricky because it’s often a “chicken or the egg” scenario.

Did the physical injury cause emotional suffering or is the physical symptom caused by emotional stress?

That is why the original purpose of filing the lawsuit is taken into consideration when looking at taxability for compensatory damages.

Emotional damages are usually measured by one of two methods. Either an expert witness testifies about the trauma the plaintiff endures, or a close family or friend of the plaintiff (or the plaintiff themselves) testifies about how the events have negatively affected the plaintiff and their life.

Damages Awarded in a Lawsuit

Money awarded in a court settlement often goes to pay for prejudgment or attorney’s fees. This helps you compensate your lawyer for their assistance in your victory.

Court verdicts or settlements decide damages. If both parties agree, a settlement is reached.

Person A and Person B could have reached a conclusion without ever going to court with the help of their insurance companies. If the decision moves on to the courthouse, a judge or jury doles out the response as a verdict.

Taxes on compensation are the same whether awarded by a verdict or a settlement.

Conclusion

Whether money earned from a lawsuit is taxable or not depends on why it was originally awarded.

Court settlements are always taxable if they involve punitive damages. Court settlements involving compensatory damages may be taxable income.

(Video) Trucking Company Mitigate Punitive Damages Liability

The reason for the lawsuit settlement is the deciding factor.

Personal injuries with physical damage are not required to be reported and therefore are not taxable, while most non-visible injuries and emotional distress cases are taxable.

If you have any questions or need help with your personal injury case, contact the experienced attorneys at Stoy Law Group today.

FAQs

Are compensatory damages taxable? ›

The Service has consistently held that compensatory damages, including lost wages, received on account of a personal physical injury are excludable from gross income with the exception of punitive damages.

Are punitive damages insurable in FL? ›

The court first noted that Florida public policy "generally prohibits insurance coverage for punitive damages for the direct wrongful conduct of an insured, even where the insurance policy specifically provides for such insurance." Florida law recognizes an exception to that prohibition, however, in cases such as this ...

Are compensatory damages taxable in Texas? ›

Because these forms of payment are not considered income, they are not included on your tax return and will not be taxed by the federal government. These kinds of damages are a form of non-punitive, compensatory damages. Because Texas does not have an income tax, they are not taxable at the state level, either.

Is court compensation taxable? ›

There's legislation in place which states that you don't need to pay tax on it, no matter whether it's a lump sum or a few payments over a period of time. It also doesn't matter whether your case was settled in or out of court - in either case, your compensation will be exempt from tax.

Are punitive and compensatory damages taxable? ›

In California & New York, punitive damages can be subject to taxation by both the state and the IRS. Because punitive damages are taxable and compensatory damages are not, it's critical to be meticulous in distinguishing each classification of damages that you're awarded in a personal injury claim.

What type of compensation is not taxable? ›

Nontaxable income won't be taxed, whether or not you enter it on your tax return. The following items are deemed nontaxable by the IRS: Inheritances, gifts and bequests. Cash rebates on items you purchase from a retailer, manufacturer or dealer.

Are punitive damages income? ›

Punitive Damages: Punitive damages are taxable and should be reported as “Other Income” on line 8z of Form 1040, Schedule 1, even if the punitive damages were received in a settlement for personal physical injuries or physical sickness.

What are compensatory damages in Florida? ›

Compensatory damages are the most common type of reward given to the injured party and are designed to recover what the plaintiff has lost as a result of the injury. Plaintiffs are awarded these damages to help them return to emotional and financial state they were in prior to the injury.

What qualifies for punitive damages in Florida? ›

(2) A defendant may be held liable for punitive damages only if the trier of fact, based on clear and convincing evidence, finds that the defendant was personally guilty of intentional misconduct or gross negligence.

What forms of compensation are taxable? ›

In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. You should receive a Form W-2, Wage and Tax Statement, from your employer showing the pay you received for your services.

What are examples of compensatory damages? ›

Examples of General Compensatory Damages
  • Mental anguish.
  • Disfigurement.
  • Future medical expenses.
  • Future lost wages.
  • Long-term physical pain and suffering.
  • Loss of consortium.
  • Inconvenience.
  • Loss of enjoyment of life.

How can I avoid paying taxes on a lawsuit settlement? ›

Spread payments over time to avoid higher taxes: Receiving a large taxable settlement can bump your income into higher tax brackets. By spreading your settlement payments over multiple years, you can reduce the income that is subject to the highest tax rates.

What lawsuit settlements are taxable? ›

Settlement money and damages collected from a lawsuit are considered income, which means the IRS will generally tax that money. However, personal injury settlements are an exception (most notably: car accident settlements and slip and fall settlements are nontaxable).

Is compensation for distress and inconvenience taxable? ›

Inconvenience and distress

It is not taxable to the extent that it relates to a person.

Are compensatory damages the same as punitive damages? ›

Compensatory And Punitive Damages

The compensatory damages awarded to plaintiffs are designed to give justice to them after being wronged. Punitive damages are designed to prevent others from being hurt by the same or similar actions.

Why are punitive damages taxed? ›

Because punitive damages are not to compensate for any loss, be it economical or emotional, they are taxable under all conditions. The IRS requires any punitive damages to be reported as “Other Income” when filing for taxes.

Will I get a 1099 for a class action lawsuit settlement? ›

1099-MISCs for Legal Settlements

You might receive a Form 1099-MISC if you receive a taxable court settlement. This form is used to report all types of miscellaneous income, including settlements from legal matters. You would report settlement income in box 3, "Other Income."

Is compensation income taxable or exempt? ›

Gross compensation income is defined as taxable income arising from an employer/employee relationship and includes the following: salaries, wages, compensation, commissions, emoluments, and honoraria.

What is considered excluded compensation? ›

Excluded Compensation means such Compensation as the Employer in its Adoption Agreement elects to exclude for purposes of this Section 1.11.

What does the IRS consider compensation? ›

A safe harbor 401(k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employee's W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits.

What forms of compensation are taxable? ›

In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. You should receive a Form W-2, Wage and Tax Statement, from your employer showing the pay you received for your services.

How can I avoid paying taxes on a lawsuit settlement? ›

Spread payments over time to avoid higher taxes: Receiving a large taxable settlement can bump your income into higher tax brackets. By spreading your settlement payments over multiple years, you can reduce the income that is subject to the highest tax rates.

What are the two types of compensatory damages? ›

Compensatory damages are intended to compensate the plaintiff of a lawsuit with enough money to cover the actual amount of the injury or loss. There are two basic types of compensatory damages, actual and general.

Will I get a 1099 for a lawsuit settlement? ›

You won't receive a 1099 for a legal settlement that represents tax-free proceeds, such as for physical injury. A few exceptions apply for taxed settlements as well. If your settlement included back wages from a W-2 job, you wouldn't get a 1099-MISC for that portion.

What does the IRS consider compensation? ›

A safe harbor 401(k) plan defines compensation as Form W-2 wages (that is, the amount shown in an employee's W-2, Box 1, Wages, tips, other compensation), less reimbursements, fringe benefits, moving expenses, and welfare benefits.

What are three different types of compensation you can receive? ›

Direct compensation involves monetary payments to employees for time worked or results obtained. Indirect compensation involves expenditures made by an employer on behalf of all employees and is typically referred to as "fringe benefits." Intangible compensation involves non-monetary rewards such as....

What do I do if I have a large settlement? ›

8 Smart Things to Do With Your Settlement Money
  1. Understand the Tax Implications. ...
  2. Get a Good Financial Advisor. ...
  3. Pay Off Debt and Save. ...
  4. Invest in Education. ...
  5. Invest in Your Home. ...
  6. Donate to Charity. ...
  7. Invest in Business, Friends, or Family. ...
  8. Enjoy Yourself!

What percentage of a settlement is taxed? ›

Banks, the United States Supreme Court ruled that a plaintiff's taxable income is generally equal to 100 percent of his or her settlement. This is the case even if their lawyers take a share. Furthermore, in some cases, you cannot deduct the legal fees from your taxable amount.

Are damages for emotional distress taxable? ›

“Emotional Distress Damages Are Not Taxable.”

Only if the emotional distress emanates from physical injuries or physical sickness are the damages tax free. That's why you might commonly see the phrase “physical injuries, physical sickness and emotional distress therefrom” in settlement agreements.

What three 3 Things Must a court consider in reviewing punitive damages? ›

418, the California Supreme Court articulated 'three guideposts' for courts reviewing punitive damages: “(1) the degree of reprehensibility of the defendant's misconduct; (2) the disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and (3) the difference between the ...

What's the difference between punitive and compensatory damages? ›

The purpose of compensatory damages is to place the injured party (plaintiff) in the same position monetarily as if the injury had never occurred, and punitive damages are awarded to punish the defendant (at-fault party).

Are compensatory damages the same as punitive damages? ›

Compensatory And Punitive Damages

The compensatory damages awarded to plaintiffs are designed to give justice to them after being wronged. Punitive damages are designed to prevent others from being hurt by the same or similar actions.

Do you have to report lawsuit settlement to IRS? ›

General rule relative to taxability of amounts received from lawsuit settlements is IRC §61 that states that all income is taxable from whatever source derived, unless exempted by another section of the Code.

What is tax free in a settlement agreement? ›

Non-taxable payments

A payment made on account of a disability or injury will not be taxable. Payments for Injury to Feelings arising from unlawful discrimination occurring before the termination of employment will also not be taxable. Outplacement counselling or training costs are not taxable.

How do I report a lawsuit settlement on my taxes? ›

If you receive a settlement, the IRS requires the paying party to send you a Form 1099-MISC settlement payment. Box 3 of Form 1099-MISC will show “other income” – in this case, money received from a legal settlement. Generally, all taxable damages are required to be reported in Box 3.

Videos

1. Going to Trial: Why Employment Law Case Verdicts Are More Successful Than You Think
(Richard Celler Legal, P.A.)
2. Taxes on Injury Case
(The S.E. Farris Law Firm)
3. Workplace discrimination in California — How do I prove it?
(Shouse Law Group Channel)
4. Are punitive damages available in Florida spinal injury cases?
(rinaldolawgrouptampa)
5. Punitive damages sexual harassment - www.wpsh.ca
(The Law on Workplace Sexual Harassment in Canada)
6. Do Personal Injury Settlements Get Taxed?
(Schenk Nursing Home Abuse Law)

Top Articles

Latest Posts

Article information

Author: Amb. Frankie Simonis

Last Updated: 11/08/2022

Views: 6205

Rating: 4.6 / 5 (76 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Amb. Frankie Simonis

Birthday: 1998-02-19

Address: 64841 Delmar Isle, North Wiley, OR 74073

Phone: +17844167847676

Job: Forward IT Agent

Hobby: LARPing, Kitesurfing, Sewing, Digital arts, Sand art, Gardening, Dance

Introduction: My name is Amb. Frankie Simonis, I am a hilarious, enchanting, energetic, cooperative, innocent, cute, joyous person who loves writing and wants to share my knowledge and understanding with you.