BP is required to set aside $20 billion in funds to compensate victims of the Gulf of Mexico oil spill. Individuals and businesses affected by the spill can file a claim for compensation for lost wages or profits. So the question is will the victims have to pay income tax?
The answer is sometimes. Let’s say you are in the business of shrimping. Normally during the course of the year $200,000 is made but because of the oil spill you only made $50,000. The loss of income can be directly attributed to the oil spill. You apply to BP for the loss in profits. They look into your case and grant your request. The $50,000 you earned from shrimping plus the $150,000 from BP is equal to the $200,000 you normally make. BP will issue a 1099Misc form with the $150,000 on it and you will use it in your gross income figure to calculate your self employed taxes.
What if the BP reimbursement is for damage done to your equipment? In this case it is not considered gross income. If the equipment is brand new then the cost you have in the equipment will equal the amount BP gave you and there is no gain. But if the equipment is used and you have fully depreciated the cost of the equipment to you then the amount BP gives you is considered gain and you will pay tax on the gain. Currently capital gains tax is at 15%.
What if the BP reimbursement is for personal physical injuries? In that case it is not considered gross income or capital gain. In other words it is not taxable income.
What if the BP reimbursement is for emotional distress? In this case it is considered gross income but only the amount in excess of medical expenses not all ready deducted for tax purposes.
The IRS has a handy little Frequently Asked Question page addressing these issues http://www.irs.gov/newsroom/article/0,,id=224886,00.html?portlet=7.