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New IRS Regulations Make Certain Damage Awards and Settlements Non-Taxable

Jan 26th, 2012

The IRS issued new regulations on January 23, 2012, regarding the taxation of damages for injuries or sickness that are received through settlement or judgment. The new regulations, 77 Fed. Reg. 3106, maintain the previous rule that emotional distress damages received through settlement or judgment are taxable income. However, if the emotional distress is attributable to a physical injury or physical sickness, then the damages may be non-taxable, and some medical expenses for emotional distress are also excluded. Another change in the regulations strikes the old requirement that to be excluded the damages must be based on an action that sounds in tort. Now, the regulations provide for much broader coverage of damages. In an employment discrimination, harassment or retaliation context, this means that a plaintiff’s recovered damages, whether through settlement or judgment, may be non-taxable if those damages resulted from physical injury or physical sickness, or if they resulted from emotional distress that was caused by or exacerbated by physical injury or physical sickness. While taxation issues may not be the first thing on an employee’s mind when they suffer workplace discrimination, workplace harassment, or retaliation for reporting wrongful activity, it is good to know that in some cases the damage settlement or judgment that results from these wrongful employment practices is non-taxable. Employees who believe that they have been discriminated against, harassed, or retaliated against should contact Clayton Wire or Emily Fiscus at Ogborn Mihm LLP immediately to discuss their potential claims. Although we are not tax attorneys, we may be able to help wronged employees get to the point where they need to worry about tax matters.