Is It Necessary To Pay Taxes For Lawsuit Settlements?

What is punitive damages

Punitive damages and compensatory                                           damages

Recently, I had won a civil lawsuit that had me preoccupied for quite some time. But the best part is, I am entitled to get a fair amount of money as damages. But now I came to know that the damages which I would receive would be subjected to taxation which slightly dampens the glow of my victory. Since I was somewhat ignorant of the taxation process, I decided to do some research on how the taxation is done and whether all damages need to be taxed or not. I hope you too will find this information useful if you are dealing with a similar situation.

Are all lawsuit settlements taxable?

Even if you win a lawsuit and are entitled to receive damages, often you won’t be able to take home the entire amount.  You are very likely to get an attorney bill, which will take away a share of it. More sobering news is that the IRS is going to lay a claim on the lump sum amount, which is sure to disappoint you.

The IRS (Internal Revenue Service) is a government agency responsible for tax collection and tax law enforcement. But not all damages are taxable. For example, the compensation for physical injury is tax-free. Suppose you had won a lawsuit against your previous employer and you receive damages as a payback, which is the amount you would have received if they hadn’t fired you. Since this doesn’t involve any physical harm, the entire amount is taxable.

Know what is Punitive damages and Compensatory damages

Punitive damages are awarded for the plaintiff as a compensation for the losses in addition to compensatory damages. Punitive damages are intended to punish the defendant and compensate the plaintiff for his losses. The court is the ultimate power to decide how much the punitive damages should amount to.

Compensatory damages on the other hand are the actual damages the plaintiff receives as compensation for his expenses on medical costs, unearned income, emotional distress, pain and suffering. The compensatory damages are considered as per the exact calculation of losses. Punitive damages mean more benefit to the plaintiff.

Compensatory damages

How to calculate punitive damages

Suppose a car company made false promises regarding the safety of the vehicle and a customer met with an accident resulting $1000 worth of damages. In a punitive damage award, the court can announce a penalty of $1,000,000 against the company. Here the plaintiff gets the benefit of earning extra money, not just the repair cost! Obviously, the IRS would swoop down on this!

I hope this article provided some insight into what is punitive damages and compensatory damages and whether they are taxable or not. Consult with a tax agent to know more details!