Do You Have to Pay Taxes on Court Winnings?

Receiving funds from a court case can seem like a significant financial gain, often perceived as a windfall. However, these court winnings are generally subject to federal income tax, similar to other forms of income. Understanding the tax implications of such awards is important for individuals who receive them. The tax treatment of court winnings can vary significantly based on the nature of the claim and the specific components of the award.

Taxability of Court Winnings

The Internal Revenue Service (IRS) generally applies a broad rule that all income, regardless of its source, is taxable unless specifically excluded by law. This principle extends to most court winnings, meaning funds received through lawsuits or settlements may be subject to income tax. The taxability of these awards hinges on the underlying reason for the payment.

Punitive damages, which are awarded to punish the defendant for egregious conduct rather than to compensate the plaintiff for actual losses, are always taxable. These damages are intended to deter similar actions by others and are not considered compensatory for any injury. For example, if a court awards $100,000 in compensatory damages and an additional $50,000 in punitive damages, the entire $50,000 in punitive damages is subject to taxation.

Awards for lost wages or lost profits are another common type of taxable court winning. If a lawsuit compensates an individual for income they would have earned but could not due to the defendant’s actions, this amount is treated as ordinary income. Awards for emotional distress that do not stem directly from a physical injury or physical sickness are generally taxable. This means that if emotional distress is the sole basis for a claim, or if it is secondary to a non-physical injury, any compensation received for it will be included in taxable income.

Interest awarded on a judgment is also fully taxable. This interest represents compensation for the delay in receiving the funds and is treated as ordinary interest income, regardless of whether the underlying judgment is taxable or non-taxable. Furthermore, if attorney fees are awarded as part of the judgment and paid directly to the attorney, these fees are still considered taxable income to the recipient of the award. The recipient effectively receives the full judgment amount and then pays the attorney, even if the funds are routed differently.

Conversely, some types of court winnings are not subject to federal income tax. Compensatory damages received on account of physical injury or physical sickness are specifically excluded from gross income under Internal Revenue Code Section 104. This exclusion applies to damages received, whether by suit or agreement, as a result of a personal physical injury or physical sickness. The term “physical injury” or “physical sickness” refers to observable bodily harm or illness, not merely emotional distress or reputational harm.

For instance, if a car accident causes a broken arm and leads to a settlement that includes compensation for medical bills and pain and suffering related to the broken arm, these amounts would generally be non-taxable. Damages for property damage are also generally not taxable to the extent they do not exceed the adjusted basis of the damaged property. If the compensation for property damage exceeds the original cost of the property, the excess amount could be considered a taxable gain.

Reporting Court Winnings

Once the taxability of court winnings is determined, the next step involves understanding how these amounts are reported to the Internal Revenue Service (IRS). The payer of the court winnings, such as the defendant, their insurance company, or the court clerk, is often required to report certain payments to the IRS. This reporting is typically done using various versions of Form 1099.

Form 1099-MISC, Miscellaneous Information, is commonly used to report taxable settlements or awards of $600 or more. For example, if an individual receives taxable damages for emotional distress not related to physical injury, or punitive damages, these amounts might be reported in Box 3, “Other Income.” Form 1099-NEC, Nonemployee Compensation, might be used if the court winnings represent compensation for services performed as a nonemployee, such as lost business profits. The payer is generally obligated to issue these forms to the recipient by January 31 of the year following the payment.

Even if a Form 1099 is not received, the income is still taxable and must be reported on the individual’s tax return. The responsibility for reporting all taxable income rests with the taxpayer, regardless of whether they receive an information return from the payer. Failure to receive a 1099 does not exempt the income from taxation or the reporting requirement.

Taxable court winnings are typically reported on an individual’s Form 1040. Many types of taxable court awards, such as punitive damages or emotional distress not from physical injury, are reported on Schedule 1, Additional Income and Adjustments to Income, line 8z, “Other income.” If the winnings represent lost business profits or compensation for services, they might be reported on Schedule C, Profit or Loss from Business, as business income.

Individuals who receive substantial court winnings not subject to withholding may need to pay estimated taxes throughout the year. The U.S. tax system operates on a pay-as-you-go basis, meaning taxes should be paid as income is earned. If an individual expects to owe at least $1,000 in tax for the year from income not subject to withholding, they may be required to make estimated tax payments using Form 1040-ES, Estimated Tax for Individuals. Failing to pay enough tax through withholding or estimated payments can result in underpayment penalties.

Reducing Taxable Winnings

While many court winnings are subject to taxation, specific provisions may help reduce the net taxable amount. A primary consideration involves attorney fees and court costs incurred to obtain the award. Understanding the deductibility of these expenses is important for accurately calculating the taxable portion of the winnings.

For certain types of taxable court awards, attorney fees and court costs can be deducted as an adjustment to income, often referred to as an “above-the-line” deduction. This means the deduction reduces adjusted gross income (AGI) and does not require itemizing deductions. This specific deduction applies to attorney fees and court costs paid in connection with a judgment or settlement involving claims of unlawful discrimination, certain whistleblower actions, or other specified claims listed in Internal Revenue Code Section 62. The deductible amount is generally limited to the amount of the taxable judgment or settlement.

For most other types of taxable court winnings, attorney fees and court costs are generally not deductible by individuals after the Tax Cuts and Jobs Act of 2017 (TCJA). Prior to TCJA, these expenses could often be claimed as miscellaneous itemized deductions subject to the 2% adjusted gross income (AGI) limit. However, TCJA eliminated these miscellaneous itemized deductions for tax years 2018 through 2025. This change means that for many taxable settlements, the gross amount received is taxable, even if a significant portion goes directly to attorney fees.

In situations where attorney fees are paid directly from the judgment proceeds, the full amount of the taxable award is generally considered income to the plaintiff. This is true even if the attorney receives their fee directly from the defendant or payer. The plaintiff then deducts the eligible attorney fees if applicable. For non-deductible attorney fees, this can result in the plaintiff paying tax on money they never physically received. This highlights the importance of understanding the tax implications before agreeing to a settlement.

Beyond attorney fees, other direct costs associated with recovering the judgment might also reduce the net taxable amount in specific circumstances. These could include expert witness fees, court filing fees, or specific travel expenses directly related to the lawsuit. However, the deductibility of these “costs of recovery” is also subject to the same limitations as attorney fees post-TCJA. They are generally not deductible for most individuals unless they fall under the specific exceptions for unlawful discrimination or whistleblower claims. Maintaining meticulous records of all expenses related to the lawsuit is important to determine any potential allowable reductions.