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Payments You Receive From a Settlement Are Taxable

Unless they are a result of injury or sickness or replace an asset

Settlements resulting from a lawsuit can arise for a number of reasons. Since August 21, 1996, all damage awards, including punitive damages, are included in taxable income unless the award was due to personal physical injury or physical sickness. Damage awards can also be paid as a result of injury to a capital asset. For example, a car careens into your home and causes damage to the structure. You sue the driver and are awarded a settlement. The amount you receive is only taxable if it exceeds the cost of the repairs to the home. Your basis in the home should remain the same, as the repairs would add to basis, and the settlement would reduce basis, generally putting you back at your original basis.

If you receive a lawsuit settlement, be sure to bring the details of the settlement to your tax preparer so he or she can determine how much, if any, of the proceeds are taxable.

Related IRS Publications: 525