It depends. According to the tax code, the only damages you can enjoy tax-free
are those that compensate you for physical injury or physical sickness.
(26 U.S.C. § 104(a).) So if this describes your case it is not taxable.
There are other reasons for awarding money damages besides
compensating you for physical injury or sickness. For instance, let's
say you had filed a discrimination claim against a former employer and
won. You receive an award for back pay and for emotional distress arising out of
this traumatic experience. Because none of this award relates to
physical harm, almost all of it is taxable at ordinary income rates.
Another type of award is known as "punitive damages," which are
intended to punish the defendant. Even if the underlying case resulted
from injury or sickness, these damages are almost always taxable.
