I know that damages paid for personal injury including punitive damages are not taxable whereas damages for lost income (say, in a discrimination case) are taxable. What about damages paid for lost property? I would assume not, but I am not sure. What about money received from victim compensation funds?
Thanks,
Rob
Title 26, the IRS code, has a chapter on exemptions from gross income, that I know, you can search your own.
IANAL (and never regretted it).
Here is what I’ve heard:
Money that compensates you for an actual loss (that is, actual damages) is not taxable. After all, it’s not income.
Money beyond that (that is, punitive damages) is income, and is thus taxable.
Sounds logical (for whatever THAT’s worth).
ETA: Kinda sounds like a legal advice question. Maybe this thread belongs in IMHO?
Sounds more like a GQ on which Rand Rover can give use the Straight Dope.
Believe it or not, the tax law on this point actually makes some sense. The general rule (referred to as the origin of the claim test) is that a settlement or judgement is includible in income if it takes the place of amounts that would be includible in income. One major exception is the one you identified for amounts received on account of physical injuries.
So, if you sue for lost wages or business profits, the award is income. If you sue because someone trashed your property, then you essentially sold your property to them, so you have capital gain if the award exceeds your basis (and a capital loss if it doesn’t).
Wait a minute. What if someone trashes your property, you sue for damages, with the judgement to be used to restore the property? By this logic, that should NOT be taxable, right? Because it doesn’t replace income, but instead restitutes actual damages.
Just to clarify because I’m in the middle of such a suit.
I’m suing my ex-landlord for not returning my security deposit, let’s say $1000. My state allows triple damages so if I sue and win $3000, the first $1000 is not income but the next $2000 is.
There’s only a gain if there is excess compensation. (i.e. $100,000 in damage is compensated for $110,000).
But, honestly, this issue is complex enough that I try to avoid generalizations entirely. Lawyers love to use terms to describe lawsuit awards that make them sound non-taxable when the tax code disagrees. So a lawyer may insist that a “recovery of damages” settlement is nontaxable, but the fine print may show that some of those “damages” were for lost wages which are taxable.
(Best example ever of lawyers’ ignorance of the tax code: A divorce settlement that tried to assign child deductions/credits incorrectly, and declared that the alimony would be nontaxable.)
The way I read this pain and suffering and punitive damages are therefore not taxable,
even if they are literally any amount.
If that is the case, then I am not tax law on the point makes any damn sense at all.
Interestingly, I just received a settlement from a class-action lawsuit today because my old temp company had rules about vacations that broke Illinois law. My gross payment was equally split, with half designated as wages (with appropriate withholdings) and half as other income (no withholding). Attached to the check was a W2 for the wages half and a 1099-MISC for the other half.