Are Compensatory Damages Taxable?

Personal injury lawsuits may result in a wide range of compensation, including compensatory damages. A common question from financially savvy litigants is: are my compensatory damages taxable?

The answer, unfortunately, is a bit complicated. Current law suggests that only compensatory damages related to physical illness or injury can be excluded from income taxes. A recent court decision, however, has challenged this law.

If you're considering filing a personal injury lawsuit you may want firm answers on the compensation you may be eligible to receive the effects on your income tax.

Get answers during a free case evaluation with a personal injury lawyer near you. Complete the form on this page and we'll connect you right away.

Compensatory Damages Defined

By definition, compensatory damages are meant to compensate the victim of a wrongdoing. They are intended to pay a plaintiff back for his or her loss.

The laws governing compensatory damages vary widely by state. Compensatory damages are the most common type of damages awarded in personal injury cases.

In some states, a plaintiff may only receive compensatory damages for concrete economic losses, such as medical bills, property damage, or lost wages.

In other states, though, a plaintiff may recover for less tangible losses, such as pain and suffering and loss of enjoyment of life.

In order to receive compensatory damages, a plaintiff must prove:

  • That a loss occurred
  • That the defendant directly caused that loss
  • And that the loss can be compensated through payment

The purpose of compensatory damages is to put plaintiffs back in the position they were in before their injury occurred. In some cases, this can add up to hundreds of thousands of dollars.

If you win your injury case and get this type of award, the big question for many people is: Do I have to pay taxes on this money?

The IRS and Compensatory Damages

As stated above, the law governing this question is a bit complex. Until 1996, the Internal Revenue Service excluded all compensatory damages from a person’s income for tax purposes.

Ten years later, however, the IRS revised this rule. Now, compensatory damages that are free from income taxation only include those for physical illness or injury.

A new development, though, may change this rule. A federal appellate court in Washington, D.C. recently ruled that taxing non-physical compensatory damages violates the 16th Amendment.

With the law currently in flux, a local injury lawyer may be a good resource for the latest information and how the current laws apply to your case.

Other Forms of Injury Compensation

In addition to compensatory damages, a personal injury claim, such as car accident lawsuit, may also seek to recover other forms of compensation, including punitive damages. The purpose of punitive damages is to:

  • Punish the defendant for particularly wrongful behavior
  • Deter future instances of such behavior
  • Aid victims with severe injuries

Due to these specific purposes, punitive damages are only award in limited circumstances. Moreover, some states have rules limiting the amount of punitive damages a plaintiff may obtain.

More realistic forms of compensation for an injury include reimbursed medical bills and property damage, as well as money for loss of life enjoyment, lost wages, lost future earning capacity, and pain and suffering.

Again, these different types of damages are treated in different ways under state and federal tax laws.

To learn more about the type of taxes you may have to pay if you win a large compensatory damages case, speak with a local injury lawyer today and get the answers you're looking for.

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