Tax Court Holds Punitive Damages in Insurance Bad Faith Action May be Taxable

Posted Thursday, April 30, 2015 by Chris Thayer

In Washington State, punitive damages are relatively rare, and are only awarded under specific statutes. This includes Consumer Protection Actions. Washington State also authorizes punitive damages under the Insurance Fair Conduct Act. In a recent case by the U.S. Tax Court, it appears that the punitive damage awards in a bad faith case, might be subject to income taxation.

In Gary L. Greenberg and Irene Greenberg v. Commissioner of Internal Revenue, No. 25420-07. (U.S.T.C. 01/24/2011) the United States Tax Court held that the recipient of insurance bad faith punitive damages were taxable income. The court noted:

The definition of gross income under section 61(a) broadly encompasses any accession to a taxpayer’s wealth. [Commissioner v. Schleier, 515 U.S. 323, 327-328 (1995).] Therefore, absent an exception by another statutory provision, damage awards from a lawsuit must be included in gross income.

The court noted that the definition of gross income broadly encompasses any addition to a taxpayer’s wealth. Therefore, absent an exception by another statutory provision, damage awards from a lawsuit must be included in gross income.

Before drawing too many conclusions from this case, a plaintiff should consult with their own lawyer and a CPA - as the result may not be binding in WA and is likely limited to its specific facts.