If I receive compensation for damages, is it taxable or non-taxable?

When a sole proprietor receives compensation for damages, is it taxable or non-taxable?

When a car hits a store and compensation is received,

• Compensation for injuries of the business owner
• Compensation to cover revenue expenses due to damage to some products or temporary inability to operate due to damage to the store
  (The business owner is unharmed)
• Compensation for damage to the store itself

We will explain these three cases separately.

Compensation received for physical or mental damage is tax-free

Compensation for damages received when an employee incurs a loss that results in physical or mental damage is tax-exempt.
(If medical treatment is required, compensation for damages is deducted from medical expenses when calculating medical expense deductions.)

In addition, compensation for damages for income compensation due to inability to work due to the loss is also tax-exempt.

Compensation for goods and expenses is taxable

When a car hits a store,

• damage is caused to merchandise
• damage is caused to the store, causing it to be temporarily unable to operate

in such cases, compensation is subject to taxation.

This is because the compensation received is considered to have the nature of substituting business income.
(in the case of merchandise, it is the same as something sold, or something that is in operation even though business is unable to operate)

Compensation to cover expenses is also subject to taxation.

In this case, the compensation is treated as income and the expenses are treated as deductive expenses.

Compensation for damage to the store itself

Compensation received for damage to assets caused by a sudden accident is tax-exempt.

However, all expenses incurred to restore a damaged store to its original state are not deductible from income, and the compensation received must be deducted.
(Detailed calculations related to asset losses will be omitted.)

To give a simple example, if the expenses incurred to restore a store to its original state are 5 million yen and the same amount of 5 million yen in compensation is received, the two will be offset.

Also, if the compensation is 6 million yen and there is a profit of 1 million yen, the profit will be tax-exempt.

Conclusion

This time, we have briefly explained how to handle taxation when a sole proprietor receive compensation for damages.

Even though it is generally called compensation for damages, the extent to which it is taxable or non-taxable varies depending on the matter.

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都築太郎税理士事務所/Tsuzuki Taro Tax Accountant Office

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