Individuals who win court awards, or receive proceeds from lawsuit settlements, or receive certain governmental benefits, often question whether the amounts received are taxable or not. The answer to this question typically is, “it depends.” What drives the result usually stems from the specifics of the facts and circumstances.
WHAT GENERALLY ISN’T TAXABLE
As it pertains to awards, settlements, and certain government benefits, some income items that aren’t generally taxable include:
- Income, disability, and death payments received in connection with military or terrorist attacks.
- Workers’ compensation awards if paid under a workers’ compensation statute.
- Compensatory awards for “personal injury” or “physical sickness”.
- Damages you receive for emotional stress caused by the injury or sickness.
- Damages awarded to reimburse medical care costs due to emotional stress.
- Disaster relief received under the Disaster Relief & Emergency Assistance Act, provided the relief is for “necessary” expenses, including housing, medical, dental, funeral and other expenses.
- Awards and damages for replacement or loss of personal property (e.g., a building you own is damaged by someone recklessly driving his/her automobile.)
WHAT GENERALLY IS TAXABLE
Some income items that are generally taxable include:
- Retirement plan benefits received under a worker’s compensation statute.
- Lost wages or income due to damages from the Gulf Oil spill.
- Damages from emotional distress that are NOT due to “physical injury” or “physical sickness”
- Back pay and damages due to emotional distress under a claim under the Civil Rights Act of 1964.
- Awards for compensation for lost profits or lost wages.
- Any amounts received as a result of a settlement where the amount represents a “pension right,” i.e., the right to the money is due to contributions not made by you.
- “Punitive damages” regardless of whether they came from sickness or injury
- If interest is credited to an award, then the interest is typically taxable.
- Copyright infringement damages.
- Any awards or damages due to “interference of business operations.” Note that most employer/ employment-related settlements and damages are considered returns of lost pay or wages. Since wages are taxable as a general income tax principle, these amounts are generally subject to income taxation, as well.
- Certain amounts received shown to be attributable to medical expenses that were previously reported as itemized tax deductions on one or more previous returns.
- Legal fees to the extent those fees can be allocated to time spent recovering non-taxable awards (if the award isn’t taxed, then the legal fees can’t be deducted.
TAXABLE OR NOT TAXABLE, IT’S STILL CONFUSING
Taxation of settlements, judgments, and certain government benefits is complex. The scenarios listed above are a mere sample and largely dependent on unique facts and circumstances. Consult with your CPA and/or tax and legal advisors.
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About the Author:
Jerry Maldonado pecializes in retirement, insurance and tax off-set strategies for professionals and small business owners. His focus is to help clients identify their definitions of legacy and financial security while simultaneously implementing innovative strategies to help make those financial goals a reality. For more information on his services, he can be reached at:
JGM Consulting LLC