Do You Really Need To Pay Taxes For Compensations?

Emotional distress lawsuit

                           Taxable lawsuit damages

The Internal Revenue Service (IRS), which is the agency responsible for tax collection and tax law enforcement, will charge you a decent amount as taxes on your compensatory damages. Taxes on lawsuits will vary depending on what kind of damages you received and how much the amounts of damages are. Many compensation damages are tax-free, while most punitive damages are considered taxable. Other than the damages exempted by the Internal Revenue Code, all other damages are taxable. The compensation damages awarded for physical injuries or sickness are generally tax-free. Let’s look into this in detail below.

Compensatory damages

These types of damages are intended to provide a compensation for the plaintiff for the damages he/she had suffered due to injuries from an accident. This compensation usually covers losses due to lost wages, costs like medical bills and pain and suffering from physical injury. Those damages awarded as a compensation for physical injury are not taxable. The IRS has clear guidelines on which damages are to be taxed and which not to.

Physical Injury

As mentioned previously, the IRS does not tax damages awarded to a plaintiff for physical injury or illness. Damages awarded to compensate for medical bills or pain and suffering are exempted from taxation. The examples for such damages are those awarded to a plaintiff who had suffered injuries due to car accidents or victims of sexual harassment.

Non-Physical Injury

The compensatory damages that you receive for non-physical harm are considered to be a taxable income. An example is the compensation damages awarded after winning a breach of contract lawsuit. Damages for emotional distress lawsuit also come under taxable damages. After winning such a compensatory award, one must report this as an income which will be later on considered for taxation.

Punitive Damages

Internal Revenue Code

                  How to tax on lawsuit damages

Though the plaintiff is compensated with more than what he had lost and suffered, the main intention of punitive damages is not to compensate the plaintiff but to punish the defendant for his wrongful deeds. There are situations where both compensatory and punitive damages are awarded for the same case like in wrongful death suits. In such cases, compensatory damages are made tax-free while punitive damages are counted as taxable income. Taxable damages include punitive damages received for emotional distress lawsuit.

To know more on taxes on lawsuits and reporting your income, it is wise to consult with qualified chartered accountants who can give you valuable suggestions on how to do it.