Call it clever, or just plain dumb luck, but IRS agents in Alabama have stumbled upon a new way to track taxpayers who are not reporting certain income. Those agents down in the Yellowhammer state have discovered that court awards of punitive damages, income that is usually taxable but that is traditionally not reported to the IRS on 1099 forms, is often reported in the newspapers.
Over a five-year period, the IRS project in Alabama netted more than $43 million in taxes and penalties as a result of reading the newspapers and tracking down recipients of punitive damages.
Although some court awards, such as awards representing lost wages or awards to pay for the costs of physical injuries, are not subject to income tax, most punitive damages, which are more like an apology than a necessity, are taxable. At present, there is no system in place for reporting these awards to the IRS and most award recipients don't report such awards on their tax returns. Giving the benefit of the doubt to these taxpayers, it is probable that they are not intentionally failing to report the income on their tax returns, but that they simply don't know the money is subject to income tax.
It is certainly possible that the IRS will attempt to enact some sort of ruling in the future requiring courts to order that a 1099 for be prepared for taxable awards. In the meantime, resourceful IRS agents are finding that a little bit of digging goes a long way towards filling the nation's bank account.