Reporting a Class Action Settlement Award on Your Taxes

[jdbofky]

My understanding is that a damage award or settlement that just puts a person in the position they were in before, without adding to their financial wealth, is not taxable. Because of the issues surrounding Chinese drywall that had to be torn out and replaced in a house, a friend received a damages settlement of $20,000. The company reported this on 1099-MISC in box 3 as "other income". The program the friend is using to do their taxes carries this to line 21 of the tax return and doesn't provide a way to make it non-taxable. Is this money taxable? If not, how should it be handled on a tax return to make it non-taxable? If it is just left off, wouldn't the IRS audit and require payment of the tax? Should the company that issued the 1099 retract it and issue a corrected one showing $0? Thanks.

[Taxing Matters]

A damage award for a physical injury or sickness (e.g. broken leg, cancer, etc) is not taxable pursuant to Internal Revenue Code § 104(a). Most other damage awards are taxable income. Generally speaking, damage awards or settlements for damage to property are taxble income. However, to the extent that the money received was actually used to replace the drywall in the house, that would be an addition to basis in the home which will reduce the taxable gain when the home is sold. And there is a special procedure that you may elect to use to deduct the costs spent for corrosive drywall drywall instead of adding them to basis. The term corrosive drywall has a very special definition. See IRS publication 547 for more details on that.

[jdbofky]

So a damage award to repair my damaged automobile is taxable? That does not sound right to me. My understanding is that a damage award that is purely compensatory, leaving you in no better financial position than before your loss, was not taxable. Are insurance claims to repair tornado damage taxable? This is beyond comprehension.

I thought only things that increased the value (or extended the life) of a home went into basis. You are saying that repairs to restore something to what it was already supposed to be go to basis? That also does not sound right.

The compensation from this class action fund did not come anywhere close to covering the actual cost of tearing out the defective drywall and replacing it. And now you say he has to pay tax on the money too? That cannot possibly be right.

[jdbofky]

I found this discussion of the matter, which is informative and helpful. It is not taxable. He is going to file his return on paper and include a statement explaining why he is excluding the 1099 amounts from his income.

Intuit Article on Chinese Drywall Settlements

[Taxing Matters]

I found this discussion of the matter, which is informative and helpful. It is not taxable. He is going to file his return on paper and include a statement explaining why he is excluding the 1099 amounts from his income.

Intuit Article on Chinese Drywall Settlements

Take a look also at the information in the publication that I linked earlier regarding corrosive drywall problems, too. That may be useful for him if it fits.

By the way, your link didn't work because it wasn't properly constructed. This link will work though: Chinese drywall settlements