In some circumstances, legal judgments can be tax deductible. However, a host of very specific requirements and qualifications surround whether a judgment can be used as a tax write off. In many cases, a judgment must be reported as income and is not tax deductible. Examine the specifics to determine whether your judgment may be eligible as a tax write off.
TL;DR (Too Long; Didn't Read)
Depending upon the legal specifics of your situation, your judgment may qualify as a tax write off.
Bad Debt Deductions
Bad debt deductions are one way in which judgments can become tax write offs. If you receive a financial judgment in your favor, but the other party is not going to pay the judgment, you may be eligible to write the judgment off as a bad debt. According to the IRS, to establish that a debt is worthless, you must prove that you've taken reasonable steps to collect the debt. If the other party is not able to pay, or demonstrates that he does not intend to pay after reasonable attempts to collect the debt, you may deduct it as a write off.
Exploring Unpaid Judgments
On the other side of the judgment, if you are not willing or not able to pay a judgment, and the other party writes it off as a bad debt, you must report the judgment as income on your taxes. Unpaid judgments may count as financial gain, and you must pay taxes on the debt if the other party gives up on collecting it. For this reason, even if you can't pay the full amount of the judgment, it's in your interest to make an attempt to avoid tax penalties.
Evaluating Personal Injuries
Personal injury judgments tread a fine line for tax write offs. After a law change in 1996, IRS tax code states that personal injury payments for physical injuries are not considered a part of gross income. Non-physical injuries, such as discrimination, wrongful termination, loss of reputation or constitutional torts do not qualify as physical injuries, so financial awards in these types of judgments count as part of your gross income. There must also be a direct link between the personal physical injury and each element of the damage award; otherwise it may qualify as gross income.
Non-Personal Injury Judgments
If you have a physical injury that isn't a personal injury, the judgment probably isn't tax deductible. For example, if you're injured on the job by another employee, any judgment you receive is typically classified as wages for IRS purposes. As wages, you're obliged to report them on your taxes as gross income and you're not eligible for a deduction. This differs from personal physical injury, so it's important to make the distinction between personal and non-personal.
Consult a Knowledgeable Tax Professional
Ultimately, tax deductions as related to judgments involves many areas of law that may be difficult to interpret, or may involve complex language and deciding factors. If you are involved in a judgment and are curious whether it could be a tax write off, consult a knowledgeable tax professional. Your judgment may fall under a specific area of tax law that is eligible for a write off, or it may not; but you can protect your interests by consulting a professional.