Are penalties from a lawsuit settlement taxable?

Question

Are penalties from a lawsuit settlement taxable at federal and state (California) levels? The lawsuit is about employees being overworked and not paid overtime. Of the settlement amount, 50% is W2 income,

35% penalty, 15% interest. Want to know because if the penalty is taxable, then my income would be higher, and to avoid tax penalties for underpayment of tax I'd either have to make estimated payments or take advantage of the prior year safe harbor rule (this year's W2 tax
110% of last year's total tax, though 100% for lower incomes).

BreadWithSpam · Accepted Answer

Punitive damages are generally considered income and taxable as such, but there are some complications (ie. punitive damages for physical injury or sickness are treated differently, afaik, but it's an area of taxation riddled with exceptions).

Pay an accountant to go through this with you. It shouldn't cost more and a couple of hundred bucks but this is money well spent.

Elle · Answer

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eagent · Answer

Punative damages are ALWAYS considered taxable income.

Compensatory damages are also taxable UNLESS they are related to a physical injury.

Thus, in your case, all the money you receive will be taxable income.

The best advice you've gotten so far is to discuss your situation with a local tax pro who is familar with legal settlements. If you don't have such a tax pro already on your list of advisors you can go to

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- the National Association of Enrolled Agents - and search for one.

Good luck, Gene E. Utterback, EA, RFC, ABA

Are penalties from a lawsuit settlement taxable?

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