If you receive a compensation payment, determining whether it is taxable can be confusing.
The general rule is that if it relates to the loss of your wages or income only, then the amount will be assessable income, irrespective of whether it is paid to you as a lump sum or on a periodic basis.
This is because the compensation is being provided as a substitute for taxable income – your wages or salary – so it takes on the same character.
Any legal fees that you incur in claiming such compensation would generally be tax deductible.
However, if your claim relates to any wrong or personal injury suffered in your occupation and you agree to a settlement, or a court order, the compensation will be tax free, whether paid as a lump sum or on a periodic basis.
Personal injury includes physical injury, psychological damage and mental injury, while “wrong” includes defamation, breach of privacy, sexual harassment, unlawful discrimination and wrongful dismissal.
Any legal fees would generally not be tax deductible.
Compensation for wrong or personal injury doesn’t need to be included in your tax return.
If the payout contains elements of both compensation for wrong/personal injury and loss of income, you may need to allocate it between the two elements.
In many cases, a court order awarding the compensation will set out the split in writing.