Is this wrongful termination settlement income taxable

[superchunkee]

My husband was terminated wrongfully from the US Postal Service after he was physically injured on the job.  He filed a lawsuit and won.  He received two settlement checks.  One that was for actual back payment income which was taxed and reported on a W-2.  The 2nd payment had no taxes taken out, and was reported on a 1099-MISC.  My question is, is this 2nd payment taxable?  Do I need to claim it as income on our tax return this year?  I was reading the rules on the IRS website and it sounds like if the damages paid were the result of a personal physical injuries (which they were) they can be excluded from being claimed.  I want to make sure I am reading that correctly.  My husband's attorney seems to believe this as well.  

https://www.irs.gov/government-entities/tax-implications-of-settlements-and-judgments 

[Opus 17 · Accepted solution]

You don't give enough information.  Settlement for injury means he was paid compensation for an injury that occurred on the job or that was someone else's fault.  I can't tell from your description if he is actually being paid for his physical injury, or if he is being paid for discrimination that was a result of the injury.  If he is actually being paid for the injury, that is not taxable, but if he is being paid for discrimination that was a (indirect) result of the injury, that is taxable.

However, there is an important additional element here.  Legal fees paid for unlawful discrimination cases are deductible from the settlement payments, even though other legal fees are no longer deductible.  You need to use the Desktop version of Turbotax installed on your own Mac or PC, instead of the online version, then follow these instructions.

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/legal-fees-related-to-unlawful-d...

Also, you must pro-rate your deduction.  That means that (for example) if 40% of the settlement is taxable wages and 60% is a non-taxable payment for injury, then you can deduct 40% of your legal fees. 

[superchunkee]

This is the exact wording on the lawsuit:

"Within seventy-five (75) calendar days of entry of this Order, Defendant shall pay [PII Removed] the sum of seventy-two thousand five hundred dollars and zero cents ($72,500.00), which is comprised of forty-three thousand dollars and zero cents ($43,000.00) in back wages and interest and twenty-nine thousand five hundred dollars and zero cents ($29,500.00) for non-pecuniary damages. This payment shall be made by check made out to [PII Removed] as the payee, and sent by priority mail to [PII Removed]".   

There were NO punitive damages awarded.  ALL of that 2nd payment of $29,500 was directly related to that physical injury that he sustained while he was on the job.  So I guess my question is, are "non-pecuniary" damages taxable?

[DianeW777]

Questions: My question is, is this 2nd payment taxable? 

• It depends. The second portion of the payment for non-pecuniary damages is not taxable if it is for physical injury and or physical distress. You seem to be quite certain of this fact. The language indicates the second payment is for physical injury. If you know you are not being paid for physical injury then 

Examples of non-pecuniary damages - 

• Pain and suffering: This includes the physical discomfort, distress, and anguish a victim experiences due to their injuries. 
• Emotional distress: This refers to the emotional suffering a victim experiences. 

As indicated by @Opus17, there is no deduction from this income for legal fees or other expenses if there is no unlawful discrimination. This would be specifically worded in your documents if discrimination is involved.

@superchunkee 

[Opus 17]

Non-pecuniary just means, not related to the loss of pay/income.  That by itself does not help you decide whether the payment is for a physical injury or for some other non-physical and non-monetary loss (like embarrassment, emotional distress, or something like that.)

And, if this was related to lost wages and physical injury only, then it may not be an unlawful discrimination case.  That would also be dependent on the facts.  

(For example, my ex-wife became disabled due to a back injury and can't work.  The employer's disability insurance company denied her claim saying she could still work because her job was mostly sitting, she replied she could not work because the pain meds affected her ability to think clearly and perform the work.  She sued the disability insurer and won. Because disability is a "protected class", it was considered an unlawful discrimination case and she could deduct her legal fees from her back wages.)

Only you know all the facts and circumstances.  It's up to you to sign the tax return that it is truthful, and it is up to you to prove your case if you are audited.