Damages

• In a civil lawsuit, one private party pursues a legal remedy against another private party. These parties can be either individuals or organizations, such as companies. If the plaintiff in the lawsuit wins, the usual reward is a financial payment from the defendant, called damages. Damages can be either compensatory or punitive.
  
  

Compensatory Damages

• Compensatory damages are damages designed to make the victim of a civil cause of action whole. For example, if Person A was at fault in a car accident with Person B and Person B suffered $5,000 in damages to his car, Person A should be made to pay Person B that $5,000 to compensate Person A for the damage.
  
  

Punitive Damages

• Punitive damages are damages beyond compensatory damages that are designed to punish exceptionally egregious behavior and discourage other people from engaging in such behavior. For example, if Person A strikes Person B in the face, Person B may be able to receive compensatory damages for any injuries suffered. Additionally, because battery is considered a particularly disfavored behavior, Person B may also be able to recover punitive damages, even if his compensatory damages were fairly small.
  
  

Taxation of Damages

• Generally, compensatory damages awarded for injury or sickness are not taxable, while punitive damages are. The rationale of the IRS is that compensatory damages simply put people in a position they were in before their injury or sickness and therefore are not income. However, punitive damages exceed the amount needed to make a person whole and are therefore a kind of windfall income.