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Tax Talk with George Saenz

Ask the tax adviser

Taxability of legal-settlement proceeds

Dear Tax Talk:
Please explain if and/or when proceeds from a legal settlement are taxable. Specifically, how are actual damages, punitive damages, and accrued interest on the award treated with respect to taxes? Are they all treated as ordinary income?
Sheila

Dear Sheila:
Generally, the only legal settlements that are not taxable are those that relate to recovery of damages for physical bodily injury. Examples of settlements that are tax-free for personal injury include a car accident, a slip and fall, wrongful death, etc.

Settlements for age or race discrimination and sexual harassment actions are taxable.

Punitive damages in a physical injury claim are not taxable. In most other claims, punitive damages are taxable.

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Prejudgment interest is always taxable, as it is not received on account of physical injury but rather on account of the time value of money.

All settlements are treated as ordinary income, not capital gains, unless the settlement relates to the sale of a capital asset, such as land or a building.

-- Posted: Oct. 25, 2001

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See Also
Reporting settlement proceeds
Taxes and contingent attorney fees
Dealing with a non-allocated monetary settlement

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