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Is a settlement or damages taxable to recipient litigant?

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    The starting point for computing an individual’s tax liability is determining what is included in gross income. Section 61 of the Internal Revenue Code (IRC) defines gross income as “all income from whatever source derived.” A widely accepted definition of income is “undeniable accessions to wealth, clearly realized, and over which taxpayers have complete dominion.” Thus, income is taxable when realized or in the year earned. IRC §§ 6041 and 6051 and Treasury Regulation 1.6041-1(f) and 1.6041-2 are the operative provisions with respect to the reporting requirements for the client receiving the settlement or award.

    Typically, any damages for non-physical injuries or sickness, all punitive damages (even if they relate to physical sickness or injury), compensatory damages for non-physical sickness or injuries arising from employment discrimination or defamation, and any other taxable damages are required to be reported in Box 3 of Form 1099-MISC. Box 3 is where you report other income that is not reportable in one of the other boxes on Form 1099-MISC. However, if an award of back pay that constitutes wages is awarded, it typically would not be reported on Form 1099-MISC, but rather on Form W-2.

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