Determining what types of income or court awards are taxable can be challenging. If you receive money from a court settlement, it is important that you know whether you need to report it as income. 

The term “damage compensation” refers to the amount that a victim receives in a lawsuit. The court promotes justice for parties who suffer a loss by awarding damages. In some cases, the victim can receive a lump-sum payment to help them overcome financial difficulties that the injuries caused. Justice can also be used to punish extreme negligence and discourage others from engaging in similar behaviors. 

 There are generally two types of damages that a plaintiff may be awarded:

  • Compensatory
  • Punitive

In a personal injury lawsuit, the defendant is the party that is accused of negligence and the plaintiff is the person who made a claim. Any damages awarded would generally belong to the plaintiff. 

Compensatory damages serve as compensation for damages caused by the defendant’s negligent or intentional actions toward the plaintiff. This compensation is designed to help the plaintiff pay any expenses that they have incurred as a result of the defendant’s negligence or intentional acts. 

Compensatory damages include: 

  • Physical injuries 
  • Medical expenses 
  • Mental anguish 
  • Impairment of quality of life 
  • Property losses 
  • Loss of wages 

Compensatory damages primarily fall into two categories: 

Economic damages include compensation for monetary expenses, such as:

  • Medical bills
  • Loss of property that requires repair or replacement
  • Loss of income caused by missed days of work

Non-economic harm includes pain and suffering, emotional distress, and reduced quality of life related to events that are the subject of the litigation. 

What are punitive damages? 

Punitive damages are designed as a form of punishment for those responsible for injuring someone else. Punitive damages can apply in situations in which the defendant acted extremely recklessly or intentionally, with a blatant disregard for the plaintiff’s safety. A San Antonio car accident attorney can advise on whether a court is likely to award punitive damages in your case. 

At the scene of a car accident, if the defendant was under the influence of alcohol or drugs when the crash occurred, the plaintiff can demand punitive damages. In this type of case, the defendant’s actions deliberately put others in danger and caused injury to the people and property involved. Damages in this category are up to a judge’s discretion and a judge is not obligated to award punitive damages in any case.

Are compensatory damages taxable? 

Compensatory damage can be taxable depending on why they are awarded. 

Bodily injury: In personal injury cases involving a car accident, compensation that a victim receives with respect to the bodily injuries they incurred is not considered taxable income and does not need to be reported. 

The definition of “physical damage” is critical here. 

To avoid being taxable, the IRS requires that physical injuries are considered to be visible. Cuts, abrasions, bruises, fractures, and other obvious injuries mean that the income the victim receives to compensate for them is not taxed and need not be reported as income. Any additional damages that a court awards must comply with the taxable regulations specific to them. 

Are Lawsuit Settlements Taxable

However, if a court awards damages and invisible injuries are involved, the IRS will generally need a portion of the money. Examples of intangible harm include sexual harassment, defamation, and libel. Emotional distress is not the same as an invisible injury, but the IRS considers it similarly.

Emotional injury: There are two types of compensation for emotional injury. If a victim receives compensatory damages for forms of emotional distress that exhibit physical symptoms, the IRS may determine that the money is taxable. In this case, a person who reports that their headaches are caused by stress, any compensation they receive for the stress-related headaches must be disclosed and taxed as income.

However, if the bodily injury causes mental pain, it can be treated as bodily injury in a personal injury case, and the damages awarded would not be taxed. These situations can be complicated because it is generally a “chicken or egg” situation.

Does emotional pain cause physical injury?

This is why the original purpose of the claim needs to be considered when determining whether compensatory damages are taxable and need to be reported. Emotional decline is generally measured by one of two methods: expert witness testimony about the trauma the plaintiff suffered or testimony from close relatives or friends who explain how the events had a negative impact on the plaintiff’s life.

Are punitive damages taxable? 

Punitive damages are always taxed, because they do not directly compensate a victim for the loss they incurred. The IRS requires that individuals report punitive damages as “other income” when submitting their taxes. 

Consulting an experienced personal injury lawyer in San Antonio and asking any questions you may have about whether your damages award is taxable can be valuable. Our team has in-depth knowledge of the relevant laws and extensive experience with handling similar cases.