are court-ordered damages taxable?
Say part of your award or settlement is tax-free (for physical injury or sickness), and part is taxable (for interest or punitive damages). You must report the full amount of the taxable portion of the award or settlement as income on your return, without any reduction for the related attorney fees. Then you can treat the fees related to the taxable portion as a miscellaneous itemized deduction item on Form 1040. A 1996 amendment to the Code expressly provides that the exclusion from income for amounts received on account of personal physical injuries does not apply to punitive damages. 30 The Supreme Court, construing the pre-amendment provisions of the Code, had already held that punitive damages were taxable. Money Received for Vehicle and Property Damage. Any compensation you receive for vehicle damage resulting from a car accident is not taxable. This is true for the costs of repairs that were paid as well as any reimbursement you might have received for a rental car while your vehicle was in the repair shop. I. Although many practitioners assume that judgments and settlements are not taxable, the issue is not quite that simple. Under section 61 of the Internal Revenue Code (” I.R.C.” or the ” Code”), damages awarded as a result of a lawsuit are taxable unless specifically excluded by another section of the Code. However, if any part of your award or settlement is deemed to be interest for the period between the physical injury or sickness and the time you get paid, that part is taxable. 1  Example: Say you were seriously injured in a 2011 auto accident. 2  You racked up $50,000 in medical expenses and $60,000 in lost wages. Property Damage. Harm to property is taxable only to the extent the recovery exceeds the basis of the property. 8 If the recovery is smaller than the basis of the property, and the property remains in the plaintiff’s possession, the basis is reduced by the amount of the recovery. 3 Thus, voluntary settlements achieved or damages awarded as a result of claims based on personal physical injuries are generally excludable from gross income. 4. In general, damages awarded for breach of contract, 5 punitive damages 6 and the interest portion of a judgment are taxable. Payments received as compensation for physical injury or physical sickness are federal-income-tax-free. It doesn’t matter if the compensation is from a court-ordered award or an out-of-court settlement, and it makes no difference if it is paid in a lump sum or installments. In a typical settlement where you receive only compensatory and general damages for your physical injuries and medical expenses, most of that amount is usually not subject to taxes. This is because that type of settlement or judgment is meant to reimburse you for your out-of-pocket losses. Fees related to tax-free compensation for physical injury or sickness are always nondeductible. For more details on the tax rules for damage awards and settlements and related attorney fees, check out IRS Publication 525 (Taxable and Nontaxable Income) at www.irs.gov.
Part of your award or settlement is tax-free for physical injury or sickness and part is taxable for interest or punitive damages.