The interest is taxable as interest.
To analyze the restitution amount, you use the tax benefit rule -- did you get a tax benefit from the expense that is now being reimbursed? You also look at your cost basis in the item.
- For the tax benefit rule, if this was theft of business equipment that you previously deducted as a business expense (expense or depreciation), the reimbursement would be business income, since you got a benefit from the expense. If the theft was a piece of medical equipment that you got a medical expense deduction on schedule A, the reimbursement would be taxable, but if you never got the benefit of the tax deduction (because you used the standard deduction or because your expenses were less than the 7.5% floor) then the reimbursement is not deductible.
- For the cost basis rule, your reimbursement is taxable if it is more than your cost basis (generally, what you paid for the item, although items used in business are subject to adjustments). For example, suppose the stolen item was a gold watch that originally cost $5000, was worth $15,000, and the reimbursement was $6000. $1000 is taxable because it is the amount over your cost basis.
