Settlements - awards - judgements
Whenever one receives money from a settlement, an award or a judgement the tax code provides for determining the taxable portion. Usually the only proceeds which are not taxable are the amounts received for personal injury. The injury can be mental.
Silent Punitive Damage Taxable
Whenever a plaintiff strikes a deal over the settlement of damages for personal injury the agreement is reduced to writing. However, if the plaintiff goes to trial and wins the court case and is awarded punitive damages then this element is not excludable from income. In the case of Lane v. U.S., Civ-94-1833-R, W.D. Okla. (8/2/95) a question arose over the existence of punitive damages because the settlement agreement apparently was silent as to the amount of any punitive damages. The court made its own allocation of punitive damages which were accordingly not excludable.
Attorneys should consider adding language to future settlement agreements addressing the existence (or nonexistence) of punitive damages and a measurement of same.
Bob Parrish CPA PC: bmsarasota@home.net or bmodessa@home.net |
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The tax treatment of money or property received pursuant to the resolution of a dispute is the same irrespective of whether the dispute is resolved through a judgment or a settlement. Whether a recovery or a payment received pursuant to a judgment or a
settlement is includible in gross income is determined based upon the nature of the
underlying claim. Several types of payments
received for personal injuries or sickness (i.e., payments under workers' compensation
acts, payments through accident or health insurance, certain pensions or annuities, and
certain disability income) are excludible from gross income. Damages received under a judgment or a settlement
are also excludible from gross income if the underlying claim seeks redress for physical
personal injuries or physical sickness. For
damages received prior to August 21, 1996, however, it was not necessary that personal
injury or sickness be physical in order to claim the exclusion. A recovery or a payment received pursuant to a judgment or a
settlement is always includible in gross income if the underlying claim alleges a
nonpersonal injury. The payment is includible
in gross income as capital gain if the claim alleges harm to a capital asset and the sale
or exchange requirement is met; otherwise, it is includible as ordinary income. Note, however, that a recovery or a payment
received in a non-personal injury case may be excludible from gross income if it is a
substitute for an amount that would be
excludible from gross income under a separate statutory provision (e.g., gifts, legacies,
etc.). Punitive damages recovered pursuant to a wrongful death action are
excludible from gross income if the applicable state law provides that only punitive
damages may be awarded in a wrongful death action. In
all other cases punitive damages are includible in gross income. From the defendant's perspective, payments made pursuant to a judgment or a settlement may be deductible as a trade or business expense; or as a production of income expense (if the activities of the defendant that gave rise to the dispute do not rise to the level of a trade or business). Instead of a current deduction, the defendant may be required to capitalize the payments if the claim pertains to sale or exchange of a capital asset. Fines and penalties are nondeductible. In addition, two-thirds of the amounts paid pursuant to certain antitrust actions are nondeductible provided there is a guilty plea or a conviction in a related criminal proceeding. |
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