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Tax Treatment of Judgments and Settlements
One of the most common underappreciated aspects of litigation is the taxation of the outcome, whether by judgment or settlement. This is true for both the plaintiff and defendant. With respect to the plaintiff, how will the litigation proceeds be taxed, if at all? As to the defendant, will a deduction be allowed at all or must it be capitalized or a combination thereof.
Origin of the Claim
The tax treatment of a payment from settlement or final determination is dictated by the "origin of the claim" doctrine. This means in lieu of what were the damages awarded or received.
If it is determined that all or part of the amount received is taxable, further analysis must be undertaken to determine if it is ordinary income, recovery of capital or capital gain. Recoveries are generally taxable and treated as ordinary income if the payments relate to lost profits except when they may be categorized as capital gain if the underlying claim is for damages relating to a capital asset.
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