When a case ends successfully (either by a judgment from a Court or a settlement), frequently the plaintiff will be awarded money damages. One question that arises after the recovery of money damages from a personal injury lawsuit or other types of cases is whether the damages can be taxed.
The answer is: it depends.*
Generally, it is a good idea to consult with an accountant or other tax professional about how the recovery of money damages might be taxable. But here are a few general things to help give some guidance in determining whether a recovery might be taxable.
As an important starting point, it is crucial to remember that income – that is, any money received from others — is generally subject to taxation by the IRS and, where applicable, state and local governments. That is not to say that receipt of damages from a lawsuit will be taxed.
But it is absolutely true that the presumption concerning any funds received should be that those funds will count as income for tax purposes unless the IRS has said otherwise.
The tax code provides that if damages from a lawsuit are paid for personal physical injuries or physical sickness, those amounts are (in most cases) not considered to be income.** This exception also generally extends to damages received for emotional distress or mental anguish if those awards originate from a personal physical injury or physical sickness.
Again, it is important to note the limits of that exception. First, damages arising from things other than personal physical injuries or physical sickness are not generally exempted from being included in income for tax purposes. Thus, where a party receives damages from a judgment or settlement in, for example, a case involving fraud or the violation of a contract, those damages are likely subject to taxation.
Second, even in a case that involves personal physical injuries or physical sickness, particular kinds of damages or other types of monetary awards may be taxable. Punitive damages, for instance, are taxable, no matter the type of suit in which they are awarded. Damages representing lost wages or lost profits may also be taxable, even where they are awarded in a personal injury lawsuit. And awards of interest associated with a judgment or settlement are generally taxable.
Obviously, this is only meant to provide a broad overview and not to suggest that particular damages in any specific case will or will not be taxable. Tax laws are complex matters and their application in any specific circumstance is not easily defined. For that reason, it is always advisable to confer with a tax expert – a tax lawyer, an accountant, or another tax professional – about whether particular damages will be subject to taxation by the IRS.
Michael J. Murray
Board Certified – Civil Appellate Law
Texas Board of Legal Specialization
WATTS GUERRA LLP
Four Dominion Drive, Bldg. Three, Suite 100
San Antonio, Texas 78257
Phone: (210) 447-0500