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What’s the tax burden on legal damages?

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in Small Business Tax,Small Business Tax Deduction Strategies

Q. I am pursuing a personal legal action where I might be paid damages. Are these damages subject to income tax? J.L., Groton, Conn.  

A. It depends. Generally, lawsuit awards and settlements for physical injury or sickness are exempt from federal income tax, but awards and settlements for other torts and awards and settlements for punitive damages are taxable. Compensation for emotional distress is taxable unless it is part and parcel of a physical injury or sickness.

Tip: Check out the laws applicable to state income tax. Your attorney can provide guidance.

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