punitive damages

Are Punitive Damages Taxable?

09/28/2020
By Logan Quirk

Recovering from serious injuries you sustained from a recent accident is a difficult undertaking. You may need to go through lengthy rehabilitation and recovery, which is why a court of law may award you with compensatory and punitive damages.

But what are those compensatory and punitive damages? That is a question we’ll be answering in great detail in this article. On top of that, we’ll also figure out if you need to worry about taxes upon receiving those financial awards.

Hopefully, you’ll never be involved in a serious accident. In case you do end up in that situation, however, learning how to handle matters such as the financial awards will be important.

What Are Damages?

In the aftermath of a court case, the party found not to be at fault for what happened but was affected nonetheless may be rewarded damages. These damages are compensation for the inconvenience and harm caused by the offending party.

Damages often come in the form of monetary compensation. Two types of damages are typically awarded by courts, with those being compensatory and punitive damages.

Let’s get into what those are in the sections below.

What Are Compensatory Damages?

Also known as actual damages, compensatory damages refer to the financial awards given to plaintiffs as a way to help them navigate the aftermath of the accident they were involved in. They compensate for a significant loss on the part of the plaintiff.

Compensatory damages can account for different expenses.

More often than not, they will cover medical expenses whenever applicable. They will cover medical bills as well as additional costs related to nursing home stays or lengthy rehabilitation. If the plaintiff needs to use equipment due to injuries sustained from the car accident, the compensatory damages will reflect that as well.

The compensatory damages can also cover for loss of property. If your car or home is damaged because of negligence from another party, the compensatory damages will account for that.

Expenses related to a plaintiff’s treatment, vehicle, and/or home are compensatory damages. Those are not the only compensatory damages you may receive. You also have general compensatory damages.

You receive general compensatory damages to compensate for a loss without a defined monetary value. An accident may have inconvenienced you, and the injuries you sustained may stop you from enjoying your hobbies. The general compensatory damages are supposed to cover for those losses.

Since there are no bills to reference, calculating general compensatory damages can be tricky. Courts may use different methods of calculation to come up with an amount to award.

What Are Punitive Damages?

Whereas compensatory damages are supposed to help make up for the losses experienced by a plaintiff following an accident, punitive damages do something a bit different.

Punitive damages serve two purposes.

First, punitive damages are supposed to offer additional compensation to the plaintiff. If the court believes that the compensatory damages set are not enough to make up for what the plaintiff has suffered, the punitive damages can remedy that.

You can use punitive damages as a corrective measure.

They impose them so the defendant can see the gravity of their actions.

The court sees punitive damages to deter negligent behavior in the future. Notably, they give them not only to deter a defendant but also to serve as examples of how financially damaging it can be to be criminally negligent.

For example, the court may want to make an example out of an irresponsible motorist who crashed into another car and left the scene to avoid liability. It’s a classic hit and run accident. To discourage other motorists from attempting to dodge responsibility that way, they may hit the motorist in question with several punitive damages to pay.

The courts never hand down punitive damages on their own. They levy them alongside compensatory damages.

When Do Courts Impose Punitive Damages?

Courts don’t award punitive damages on a whim. They often take several factors into account when making this kind of decision.

According to Investopedia, the criteria courts use when deliberating whether or not to impose punitive damages varies from one state to the next. Don’t be surprised if you find the data to be all over the place when looking up how they award punitive damages.

Still, there are essential factors that courts almost always consider when deciding punitive damages. These include the intent of the defendant and historical precedent.

Courts will take a closer look at the evidence and try to see if the defendant intentionally caused the accident. The court may still decide to impose punitive damages even if the accident was unintentional if they deem the defendant to be overly negligent or having some other kind of malicious intent.

Courts also like referring to previous cases when handing down verdicts of their own. Upon seeing that similar cases led to giving punitive damages, the judge in your case may follow that pattern.

How often Are Punitive Damages Included in the Final Verdict?

After learning that courts often consider the intent or mindset of the defendant in the case as well as historical precedent, you might assume that they levy punitive damages all the time. That is not the case, however.

According to Cornell Law School, they only award punitive damages in about five percent of verdicts.

So, what does that mean for your case? It means that you and your lawyer must push harder for the defendant to pay the appropriate amount in compensatory damages.

With no guarantee that the court will include punitive damages in the decision, you must be comprehensive when detailing how the accident has affected your life. The after effects of the accident may also make it harder for you to return to any semblance of a normal life in the near future. The compensatory damages should account for that and compensate you accordingly.

How Are Punitive Damages Calculated?

Actual compensatory damages are easy to calculate because there are medical and repair bills that are available for reference. General compensatory damages are tougher to calculate because they are more intangible. Still, courts can reference the dollar amount assigned to the actual compensatory damages and use that as a reference point.

But what about punitive damages? How do you calculate for damages that take into consideration both the plaintiff and the defendant?

To clear things up for lawyers and their clients, the Supreme Court, and the states themselves offered some helpful guidelines.

One of the main factors in the equation is the reprehensibility of the act committed by the defendant. In cases where there is clear and obvious neglect on the part of the defendant, the punitive damages paid out may be higher. Punitive damages will skyrocket if the evidence shows that the defendant was acting intentionally to harm the plaintiff.

The courts will similarly consider the awarded amount of compensatory damages set in the case. The punitive damages must be at an acceptable ratio relative to the compensatory damages.

Do note, though, that punitive damages can exceed the total amount of compensatory damages awarded. The only standard that most courts follow when determining the appropriate ratio is to ensure that the punitive damages are no greater than four times the amount of the compensatory damages.

States typically influence how punitive damages are determined by imposing limits. They may have passed laws in the past, which dictate the maximum amount of punitive damages awarded for a specific type of case.

Are Punitive Damages Taxable?

Among the things that you may not consider while you’re in the middle of a trial or pursuing a settlement against the defendant are taxes. While it’s perfectly understandable that your focus is elsewhere at the moment, you cannot afford to neglect paying the appropriate amount of taxes. Failing to do so could lead you to run afoul of the law.

The good news is there is no confusion when it comes to taxes on punitive damages. The IRS clearly states that the punitive damages you receive as part of a financial settlement are taxable.

The agency reminds recipients of punitive damages to report the financial award as a type of “Other Income.” You must note it on line 21 of Form 1040, Schedule 1. You must pay taxes on the punitive damages received regardless of what kind of settlement you received.

Enlist the help of your lawyer to settle the matter of taxes on your punitive damages. If you’re still recovering, you should leave these potentially headache-inducing matters to your lawyer.

Are Compensatory Damages Taxable?

Unlike with punitive damages, figuring out if you owe taxes on the financial award you received due to compensatory damages is significantly more confusing.

Let’s try to parse through the matter below.

If the settlement you received is to cover personal injuries or sickness and you did not take an itemized deduction for medical expenses related to those in previous years, then the compensatory damages are non-taxable.

When it comes to compensatory damages for emotional distress or mental anguish, the same rules apply. The full amount of compensatory damages received is non-taxable, provided you did not take itemized deductions related to the emotional distress or mental anguish stemming from the injuries or sickness you sustained.

Now things get more complicated.

Upon receiving the settlement, you must report as income the portion of the settlement that is supposed to cover the medical expenses that you took deductions on in previous years. That’s assuming that those deductions offered a tax benefit.

The compensatory damages you receive to cover for emotional distress or mental anguish are taxable as long as those did not originate from the personal injuries or sickness you developed as a result of the accident. You must report it as income.

However, you can reduce the amount you report as income by the money paid to cover medical expenses related to emotional distress or mental anguish that you did not deduct previously. You can also reduce the amount by the deductions on medical expenses you took previously to address emotional distress and mental anguish as long as they were not beneficial to you tax-wise before.

There is one more thing that we should mention here. If you are accruing interest on settlement payments, they regard the interest as taxable interest income. You must report it on line 2b of Form 1040.

Why Hiring a Lawyer Is a Must if You’re Dealing with Compensatory and Punitive Damages

The aftermath of being involved in a serious accident can leave a person unable to experience normal life for an extended period of time. Asking that person to handle matters related to calculating damages, pursuing them in court, and then worrying about taxes would be too much.

Those are tasks best left to experienced lawyers.

An experienced lawyer can help you figure out the right amount of compensation to aim for during a court case. A good lawyer will also help you determine which course of action to take when deciding between either going to court or accepting a settlement.

Do not hesitate to hire a lawyer who can help you navigate what can turn out to be a trying ordeal. We at the Quirk Law Group are more than ready to help plaintiffs seeking compensation. Contact us today and allow us to help you put together your case.

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