Are Judgments Taxable?
A question that arises in civil litigation is, are judgments taxable? The answer depends on the specific case and circumstances. A judgment for emotional distress, for example, may not be taxable, even if it demonstrates the recipient's distress. The original purpose of the lawsuit is taken into account to determine taxability. Punitive damages are almost always taxable. If you are awarded a judgment for emotional distress, you should check with the IRS for more information.
If the judgment awarded you is for physical injury, then the interest accruing on that amount is taxable. Unlike other types of damages, however, emotional distress can be compensated for by the judgment. In other words, if you have a migraine headache because of your job's atmosphere, you can claim emotional distress damages. It's important to note that the IRS will consider both types of damages when determining tax liability.
A judgment may not be taxable, but a settlement may be. In either case, the settlement and judgment terms will have a substantial impact on the tax treatment. Settlement agreements are often more flexible and clear about the purpose of the payment. While there are some differences between a judgment and a settlement, the overall tax treatment of settlements is similar. The only exception is if the judgment is for personal injury. For more information, contact the IRS' Office of Taxation.
For example, if you receive a judgment that's worth less than your basis in your condo, the amount of the settlement won't be taxable. But if the judgment is for an egregious action, then you might be required to pay taxes on your attorney fees, since they're no longer deductible on Schedule A. In addition, settlements and judgments may involve multiple issues with varying tax treatment. So, your disposition agreement should clearly indicate which ones you allocate to which issues.
Emotional distress can also lead to taxation. For example, if you win a lawsuit for a car accident, the settlement you receive may include emotional distress. However, emotional distress won't be taxed if it results from physical injuries. But, even if the emotional distress caused by the accident was taxable, the emotional distress settlement may be. If this is the case, you should consult with an accountant.
Judgments are taxable in the same way as other income, and if you receive punitive damages, you'll have to report it as such. Punitive damages, on the other hand, are meant to punish the defendant for extreme or outrageous behavior. Punitive damages are always taxable and must be reported on your tax return as 'Other Income'. You must note, though, that punitive damages are only a small portion of your total compensation.
When determining whether your judgment is taxable, the IRS looks to a variety of factors. The court-imposed judgments, settlements, and other legal documents, and any settlement agreements between the two parties, may all have some impact on the tax treatment of your judgment. However, they may still be taxable if you have received a lump sum payment from them. Therefore, you should discuss your case with an attorney and make sure that you understand how to calculate the tax liability on your settlement.