Are compensatory damages taxable? If you are awarded a sum for your suffering, you must decide whether you will report it as income or not. Personal injury compensation and mental anguish compensation are not taxable, but you need to report them as income if you are receiving them for an emotional or psychological trauma. However, you can deduct medical expenses you incur for treating the emotional distress or mental anguish, as well as any previous deductions you may have made.
The amount of compensation that you receive can be divided among the various claims that you may have against the defendant. While the compensation for medical bills and ambulance services are not taxable, compensation for pain and emotional distress is. This amount can be used to rebuild your life after the accident, purchase durable medical equipment, modify your home, or start a new line of work. However, most people do not need to pay taxes on these amounts.
Physical injury awards are also not taxable, unless the award is based on an injury. For instance, if you sued a company for sexual discrimination, the physical injury award may be excluded from the total amount of compensation that you receive. If you receive a compensatory damage award for any other type of injury, you must include the physical injury portion on your tax return. However, if you are awarded a settlement based on emotional trauma, you must report the compensation for mental anguish and pain and suffering.
The IRS has a specialized definition for compensation for physical injury and illness. It deems emotional distress as a physical symptom. However, damages for emotional distress are not taxed. The IRS looks at the original purpose of the lawsuit when determining if they are taxable. As long as the physical injury is visible, compensatory damages are not taxable. A jury will not tax emotional distress. It is still important to remember that emotional injury and emotional distress damages are different from each other.
Despite its distinctions in purpose, you need to understand what constitutes a taxable amount of compensation. A judgment is a formal resolution by the court, and a judgment can award money damages to one party. A settlement is a mutual agreement between the litigants. Both types of settlements are tax-deductible, but they differ in other ways. Personal injury settlements are an exception to this rule. However, if you receive money as compensation for an injury caused by another party, you can retain as much of it as possible.
Another important distinction between taxable and non-taxable amounts of compensatory damages is the governing laws in your state. Oftentimes, the IRS does not tax these types of damages, but they do tax punitive damages. In cases of wrongful death, however, punitive damages are tax-free. The IRS does not consider them as taxable, so your case will be handled differently. However, you may still have to file taxes on compensatory damages if you receive them.