Are Lawsuits Taxable?

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One issue that has generated some controversy in the legal and tax world is whether or not lawsuits should be classified as tax-deductible expenses. Some have raised the concern that awarding punitive damages to a defendant in a civil suit could create a potential tax burden. Opponents argue that the statutes that allow such awards, Sec. 7 Patriotic Act do not authorize such a tax-deduction. The argument goes on to say that even if Congress may have designed the tax law in such a manner as to avoid a tax burden, that argument does not mean that the tax law should be applied retroactively to all cases.

One of the arguments that has been made in support of the idea that lawsuits are not taxable is that damages for injuries caused by others cannot be awarded as a taxable item.

This argument seems to make sense when one considers that in many cases the injured party will recover damages from its own insurer. But consider also that an award to a third party does not mean that the awarded damages can then be charged as a tax-deduction to the party that was guilty of the wrongful death. It appears that most states consider wrongful death lawsuits to be actionable and subject to tax assessment. So, whether the award is considered a taxable expense depends on the determination of each state’s laws.

Proponents of legislation that would exempt lawsuits against corporations point out that there is nothing in the tax code that authorizes such a provision.

They point out that even if a corporate citizen is damaged by the actions of its corporation, it is not punished for those actions. The argument advanced is that whether the damages are awarded as compensatory damages or punitive damages is a decision that is left to the courts.

In considering the impact of awarding punitive damages, many lawyers and tax experts opine that in the majority of states the decision as to who receives the damages is made by the jury.

The jury’s reasoning may be influenced by factors such as the nature of the injury, the financial impact upon the victim’s family, the amount of suffering caused, the extent of the injury, the emotional impact upon the surviving family members, the likelihood of an award being granted to the plaintiff, the ability of the defendant to pay, etc. The fact that a plaintiff’s injuries were caused by the recklessness or negligence of another makes no difference in the jury’s decision. Whether or not the punitive damages are awarded is determined at trial.

If a plaintiff’s attorney is successful in pursuing the claim, it is not always necessary to award treble damages.

In some cases, the attorney may have already been successful in obtaining an award of general damages for the loss suffered, and this would already be considered as a taxable event. In other situations, it may be necessary to add the treble damages into the overall settlement to increase the compensation received. A tax liability on the claim is often times wiped out by the reduction of the claim to the actual tax liability on the actual loss.

It should be noted that in cases where tax issues may arise, it is often in the best interest of the party pursuing the lawsuit to settle the claims with the Internal Revenue Service for a reasonable tax payment.

Cashing in on lawsuits is nothing new, but the recent burst in lawsuits regarding medical malpractice has resulted in many lawsuits being filed that have been clearly designed to avoid paying taxes on the basis of future recoverable losses. One should not hesitate to consult a qualified tax attorney if they have tax issues that seem to be of a personal nature. There are numerous firms that specialize in representing plaintiffs in these types of lawsuits. If you are having a problem with the Internal Revenue Service, or other tax related issues, you should always seek the advice of a tax attorney.

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