Legal Settlement - Taxable vs. Nontaxable

Per IRS Publication 17 Your Federal Income Tax (For Individuals), page 72:

Court awards and damages. To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. The character of the income as ordinary income or capital gain depends on the nature of the underlying claim. Include the following as ordinary income.

  1. Interest on any award.
  2. Compensation for lost wages or lost profits in most cases.
  3. Punitive damages, in most cases. It doesn’t matter if they relate to a physical injury or physical sickness.
  4. Amounts received in settlement of pension rights (if you didn’t contribute to the plan).
  5. Damages for:
    a. Patent or copyright infringement,
    b. Breach of contract, or
    c. Interference with business operations.
  6. Back pay and damages for emotional distress received to satisfy a claim under title VII of the Civil Rights Act of 1964.
  7. Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.
  8. Attorney fees and costs relating to whistleblower awards where the underlying recovery is included in gross income.

Don’t include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

To enter a description and an amount for IRS Schedule 1 (Form 1040) Additional Income and Adjustments to Income, Line 8:

  1. From within your TaxAct return (Online or Desktop), click Federal (on smaller devices, click in the top left corner of your screen, then click Federal).
  2. Click the Other Income dropdown, then click Prizes, awards or other miscellaneous income.
  3. Continue with the interview process until you reach the screen titled Miscellaneous - Amounts Received, then enter information for data entry fields Description and $.

When you print your return, the text "See Attached" will print to the left of Line 8 on Schedule 1 (Form 1040). A sheet titled "Other Income - Supporting Details for Schedule 1 (Form 1040), Line 8" that includes the description and the amount entered will print with the return.

For more information, also see IRS Publication 525 Taxable and Nontaxable Income and IRS Publication 4345 Settlements - Taxability.

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