Much is said about punitive damages and how they are used topunish wrongdoers. Plaintiffs dream of large punitive damageawards. Plaintiffs’ lawyers who obtain large punitive damage awardsuse them to brag about their ability as tort lawyers and as abludgeon on other defendants to convince them to settle for morethan they owe. What the litigants and litigators seldom considerare the tax consequences of a large punitive damage award. Failureto properly advise a plaintiff seeking punitive damages about thetax consequences of success can result in claims of legalmalpractice.

What is the purpose of punitive damages?

Punitive damages are intended to punish the wrongdoer. They donot compensate the plaintiff for lost wages, pain, suffering,property damage or any other damages designed to place theplaintiff back to the way he was before the tort caused damage.Punitive damages are considered a windfall to the taxpayer and mustbe included when the plaintiff files his tax return as taxableincome. Section 104 of the Internal Revenue Code deals with thetreatment of punitive damages. Section 104(a)(2) excludes fromincome only "damages (other than punitive damages) received . . .on account of personal physical injuries or physical sickness."Therefore, punitive damages, even in connection with personalinjuries, may not be excluded from income.