Is Your Personal Injury Settlement Taxable?

Before you settle your personal injury case, think about the tax consequences and how to minimize Uncle Sam’s portion of the pie.

Updated by , J.D. · University of San Francisco School of Law
Updated by Stacy Barrett, Attorney · UC Law San Francisco

Before you accept a personal injury settlement, it's important to understand the true value of the settlement offer. Ask yourself, how much money will actually reach my bank account? You've likely already accounted for deductions like your attorney's contingency fee and investigation "costs." But you also need to think about how much money you could owe in taxes.

According to the IRS, the key question to ask is: "What was the settlement intended to replace?" Lawyers sometimes call this the "origin of the claim" test. Here is an overview of how the IRS treats personal injury settlements and judgments. (26 U.S.C. § 104.)

Reason for Compensation



Physical injury or physical sickness


Emotional distress related to physical injury or physical sickness


Loss of income related to physical injury or physical sickness


Emotional distress unrelated to physical injury or physical sickness


Interest received on personal injury settlements


Punitive damages


The tax code is notoriously complicated. Many rules are riddled with exceptions and gray areas. The best way to prepare for the potential tax consequences of a personal injury settlement or award is to talk to your personal injury lawyer and a tax attorney or a certified public accountant.

Compensation for Physical Injuries Is Not Taxable

IRS Section 104 explains that money a taxpayer receives as compensation for a physical injury or physical sickness isn't taxable. The tax treatment is the same whether you get the money in a settlement or after you win your case at trial.

When you are injured because of someone else's negligence or intentional wrongdoing, you're entitled to compensation for your damages. Damages include compensation for out-of-pocket expenses, like medical bills and lost income. Damages may also include compensation for non-economic harm like "pain and suffering."

So long as your damages are related to a physical injury or physical illness, they aren't taxable. For example, if you settle an insurance claim for $18,000 after you break your leg in a car accident, the IRS typically won't take a portion of your funds. But if you develop post-traumatic stress disorder (PTSD) from witnessing a car accident, your damages would be taxable because you suffered no physical injury.

Compensation for Emotional Distress Alone Is Taxable

As noted, a personal injury settlement or award isn't taxable if it arises from a physical injury or physical sickness. But awards and settlements for non-physical injuries like emotional distress, mental anguish, defamation, and humiliation are taxable unless the distress can be attributed to a physical injury.

For example, if you're the victim of a dog bite, you can get non-taxable compensation for your physical injuries and emotional distress related to the attack. But if you develop PTSD after a dog chases you through a park, your compensation would be taxed because your PTSD didn't arise from a physical injury.

Punitive Damages and Interest are Taxable

Most damage awards and settlements are meant to make injured people "whole" again by compensating them for harm caused by someone else's carelessness. Punitive damages are different. A punitive damage award is meant to punish the person or organization that caused harm.

Punitive damages are taxable and should be reported as "Other Income" even if they relate to physical injury or sickness. For example, let's say you were injured by a defective airbag. You get $75,000 in compensatory damages and $1 million in punitive damages. The $75,000 is tax-free, but the $1 million is fully taxable.

Interest on settlements and judgments is also taxable and should be reported as "Interest Income."

Are Personal Injury Settlements Taxable on the State Level?

Most taxpayers pay state and federal taxes on income. State tax rules vary, but most states follow the federal government's lead and don't tax most personal injury settlements and judgments.

Talk to a local lawyer or tax professional for more information about the rules in your state.

Allocate Your Damages to Limit Tax Liability

Most legal disputes involve multiple issues and multiple types of damages. If possible, the parties should agree on how much is paid and its tax treatment. For example, if you're agreeing to confidentiality as part of your personal injury claim, set a dollar amount as compensation for confidentiality and allocate the rest as compensation for your physical injury. You might owe taxes on the amount paid for the confidentiality agreement, but you'll owe no taxes for the compensation you received for your physical injuries.

Agreements by the parties about tax treatment are not binding on the IRS or the courts, but allocating your settlement gives you the best chance of limiting your tax liability.

A great example of why allocating damages is important is a case involving Dennis Rodman. Rodman, a professional basketball player, was playing in a game between the Minnesota Timberwolves and the Chicago Bulls in 1997. During the game, Rodman landed on a cameraman named Amos and kicked him. Amos went to the hospital briefly and Rodman paid him $200,000 for his injury with an agreement that the terms of the settlement would "forever be kept confidential."

Amos didn't pay taxes on the settlement and ended up in Tax Court. In 2003, the Tax Court ruled that of the $200,000, $120,000 was for Amos's physical injuries (non-taxable) and $80,000 was really for confidentiality (taxable).

Talk to a Lawyer

The best way to make sure you're following the tax code is to talk to a lawyer and a tax professional. Tax rules are complicated and the consequences for not following the rules can be harsh. A lawyer can help you maximize your personal injury settlement and answer your questions about your tax obligations.

Learn more about getting help from a personal injury lawyer.

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