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A video explaining the tax consequences of a distribution of punitive damages on bad faith in the recipient



Watch the full video at https://youtu.be/hJKvhzUeJGs Chapter19659002achteIn O’Gilvie v. USA 519 U.S. 79, 117 S.Ct. 452, 136 L.Ed.2d 454 (1996), the Supreme Court ruled that punitive damages are included as gross income for tax purposes. According to the Supreme Court, "the primary focus of Congress [in enacting the amendment] was on what to do for non-physical injuries, not on the provision's coverage of punitive damages under existing law." The court clarified the law and found that punitive damages are not exempt from gross income. [ Fabry v. Comm’r 223 F.3d 1261, 1265 n. 14 (11th Cir.2000) and Foster v. U . (11 Cir., 2001)

If Congress were to choose a type of receipt of money that would primarily be a fair mark for taxation, it could very well be "windfall." It cannot be questioned that punitive damages recovered by the defendant greatly improved his ability to pay. Recognizing that one reason for adopting the Sixteenth Amendment was to place the tax burden on solvency, the Seventh Circle concluded that the term "income" used in the Congress of that amendment was intended to include punitive damages in income if it had the constitutional power to do so. Section 22 (a) of the Internal Revenue Code provides:

"Gross income" includes profits, profits and income from wages, salaries or compensation for personal services * * * of any kind and in any form paid, or from professions, professions, trade, business, trade or sale or trade in property, whether real or personal, arising out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities or transactions of any business pursued for profit or profit, or profits or profits and income derived from any source. [26USCA§22a Commissioner of Int. Reef. v. Obear-Nester Glass Co ., 217 F.2d 56 (7th Cir., 1954)

When the portion of the settlement income that represented punitive damages was not entitled to exclusion from gross income under 26 U.S.C. Sec. 104 a) (2) it is income and is taxable. [ Commissioner v. Miller 914 F.2d 586 (4th Cir.1990)]

I Gary L. Greenberg and Irene Greenberg v. Commissioner of Internal Revenue No. 25420‑07 (USTC 01/24/2011) The United States Tax Court dealt with a recipient of insurance-related criminal damages who tried to avoid tax on the allotment. The award of punitive damages for the insurer's misconduct resulted in a large tax consequence and not the case that the plaintiffs thought they received. As Greenbergs could not convince the tax court of their position, the court not only struck down Greenbergs to confirm a tax shortfall of over $ 1 million, but further sanctioned them with an accuracy-related penalty, as the taxpayers had neither substantial authority nor reasonable cause behind theirs. attitude in awarding damages. The tax court found that the definition of gross income largely includes all additions to a taxpayer's wealth. Therefore, in the absence of an exception to another statutory provision, damages from a lawsuit must be included in the gross income.


© 2020 – Barry Zalma

Barry Zalma, Esq., CFE, now limits his practice to employment as an insurance consultant specializing in insurance coverage, handling insurance claims, bad faith and insurance fraud almost equally for insurance fraudsters . He also serves as an arbitrator or mediator for insurance-related disputes. He practiced law in California for more than 44 years as an insurance coverage and attorney management attorney and more than 52 years in the insurance industry. He is available at http://www.zalma.com and zalma@zalma.com.

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