Taxes on a Court Settlement
- The IRS does not tax settlements related to personal physical injury. Any money you receive due to physical injury or illness is not counted as income by the IRS. You are not required to report it as income and it will not be taxed. Some settlements due to emotional stress are also not taxed, though this is a highly complicated matter of tax law. Punitive damages are taxed at the same rate as regular income.
- In addition to punitive damages, some parts of a court settlement might be subject to taxation at ordinary income tax rates. Interest on your settlement is taxable as normal income, as are compensation for lost profits and wages. Damages awarded in tort cases surrounding intellectual property infringement, breach of contract and interference with business are likewise taxable. All age discrimination awards are taxable.
- Emotional damages are very complicated under tax law. The IRS does not require you to pay taxes on emotional damages directly related to your injury and illness. This is highly subjective, and it is best to consult a qualified attorney familiar with tax law. Evidence that will bolster a claim that your emotional damage award is tax deductible includes bills for mental health problems and receipts for medications related to your mental health.
- No two court settlements are the same, of course, and it is always best to talk to a legal professional to help answer tough questions specific to your situation. A good rule of thumb, however, is that compensatory damages are not taxed, while punitive damages are. While not perfect, this will help give you some ballpark idea of whether or not the award you just received needs to be reported to the IRS.