Compensatory Damages Not Taxable According to Federal Appellate Court
Until 1996, the Internal Revenue Code excluded compensatory damages--those damages included to "make whole" a plaintiff or restore a person to their pre-injury status--from the definition of "income" for tax purposes. However, ten years ago the statute was revised to exclude only compensatory damages related to physical illness or injury.
In a tort case decided today, the United States Court of Appeals for the District of Columbia held that inclusion of non-physical compensatory damages in the definition of "income" for tax purposes violates the 16th amendment.
Relying on the definition of income as a "gain", the appellate court held that damages intended to restore a person to pre-injury status could not be considered income, even where the losses were not physical or economic.
The ruling may be appealed, but if it stands it will mean that compensatory damages in personal injury cases are no longer taxable, even if they are awarded for intangible injuries like emotional distress and loss of reputation.