I read an article online that said if it was attributed to emotional illness that would suffice. Is that not the case?
A: No it is not the case -- though I wish it were. In Blackwood v. C.I.R., 2012 TC Memo 190 (USTC 7/11/2012), the U.S. Tax Court writes:
- In order for damages to be excluded from gross income under section 104(a)(2), the taxpayer must demonstrate that: (1) the underlying cause of action is based upon tort or tort type rights and (2) the damages were received on account of personal injuries that are physical or a sickness that is physical. See sec. 104(a)(2); Commissioner v. Schleier, 515 U.S. at 337. The flush language of section 104(a) provides that emotional distress shall not be treated as a physical injury or physical sickness.
The Tax Court continues to write in the same vein. The conclusion is that in order for damages from emotional injuries to be excluded from gross income, the emotional injury must manifest itself directly from the physical injury or illness. In the Blackwood case, a discussion of how emotional injuries can arise from multiple sclerosis, which is a physical illness. But, absent some specific physical injury or illness, depression, anxiety, etc., is not sufficient grounds to exclude a damage award under IRC 104(a)(2).
Also part of it is a per diem fine for intercepting their communications. Are those fines taxable?
A: The fines, for the purposes of a settlement are not fines. Only a court can impose a fine. Money reduced to a settlement is compensation in exchange for the agreement to settle the case and dismiss the defendant from further liability. So, there is no fine imposed as part of a settlement. It's all just an agreement to pay $X to end the case and release the defendant from further liability.
The only way to make the settlement nontaxable is to write it in a manner that compensates the plaintiff for physical injuries or illness, caused by defendant.
Note: Were this a case where the plaintiff was attempting to recover money from the defendant which was misappropriated from plaintiff, that could be what is called a "return of capital," i.e., the plaintiff is not being compensated, but rather is receiving his/her own money back as part of the settlement. In such a case the capital returned is not taxable, because there's no income -- the defendant is simply returning to plaintiff what was already plaintiff's to begin with.
I don't see how you could use this "return of capital" concept to avoid tax liability in your circumstances -- but, I'm mentioning the legal concept to be thorough.
Hope this helps.