Is a Personal Injury Settlement Taxable?

You’ve reached a settlement for your injury claim and finally see a light at the end of a long road. But one question remains: is a personal injury settlement taxable?

The short answer is that most aren’t. The IRS generally excludes compensation for physical injury or illness from taxable income. Still, certain parts of a settlement can be taxed, depending on what they cover and how they’re written.

Understanding what is and isn’t taxable helps protect your recovery and avoid surprises when tax season comes around.

Thorsnes Bartolotta McGuire has spent nearly five decades representing injured people and recovering more than $2 billion in verdicts and settlements. Below, we explain how personal injury settlements are treated under federal tax law and what to know before you file your return.

If you have questions about how your settlement might be taxed, our attorneys can review the details and explain the applicable tax implications in your specific situation. Contact us at (619) 236-9363 for a free case review.

How the IRS Views Personal Injury Settlements

Under Section 104 of the federal tax code, money received due to a physical injury or physical sickness is generally excluded from taxable income. This includes compensation from both a lawsuit judgment and a negotiated settlement, whether paid as one lump sum or in installments.

This rule applies to many types of damages that make up a typical injury settlement, including reimbursement for:

• Medical expenses,
• Pain and suffering connected to a physical injury, and
• Emotional distress caused by the injury itself.

These amounts are viewed as restoring you to where you were before the injury, not as income you earned. Because of that, are personal injury settlements taxable? In most cases, no, they fall outside what the IRS considers taxable income.

However, this protection doesn’t apply to every dollar in a personal injury settlement. Some types of damages count as income and must be reported when you file taxes.

How Are Personal Injury Settlements Taxed?

While the compensatory portion of a personal injury settlement is typically tax-free, there are exceptions. The IRS taxes certain components because they are viewed as income or as gains unrelated to the injury itself.

Here’s what is taxable:

• Punitive damages. These payments punish a defendant for egregious conduct rather than compensate for losses. The IRS always considers them taxable income.
• Interest on the settlement. If your settlement earns interest while held in escrow or accrues after judgment, that interest is taxable.
• Lost wages or lost profits. When a settlement replaces income you would have earned at work or through a business, it is taxed as if you had earned that income.
• Emotional distress unrelated to a physical injury. If emotional distress stems from discrimination, wrongful termination, or another non-physical claim, the compensation is taxable.
• Medical reimbursements previously deducted. If you deducted medical expenses in a prior tax year and later received reimbursement for those same costs, that portion becomes taxable up to the amount of the deduction.

Article 104 of the tax code states explicitly that punitive damages are not excluded from gross income. These awards are relatively uncommon, but when they occur, they are always taxable.

How to Report a Taxable Settlement

Taxable portions of a settlement are reported as income on the tax return for the year the money is received. For those with compensatory awards based on physical injury or sickness, there is no need to report those funds at all.

For taxable awards such as punitive damages, lost wages, or interest, list the amount under “Other Income.” In these cases, attorney fees are included in the total taxable amount, even if the lawyer was paid directly out of the settlement.

To reduce the taxable share, parties may reach an agreement allocating portions of the settlement to non-taxable categories, such as physical injury or medical expenses. The IRS generally honors such written allocations if they reflect the intent of both parties.

If you have questions about are personal injury lawsuit settlements taxable, an experienced attorney can review your settlement terms, clarify what may be taxable, and help you protect as much of your compensation as possible. 

You can connect with Thorsnes Bartolotta McGuire by calling (619) 236-9363 or sending a message through our online contact form to learn more.

The Tax Benefit Rule and Medical Expense Reimbursements

The tax benefit rule comes into play when medical expenses were already deducted on a prior tax return. Its purpose is to prevent double benefits—getting both a deduction and a tax-free reimbursement for the same expense.

How the rule applies:

Scenario A: You did not deduct your medical expenses.

If you took the standard deduction and did not itemize medical expenses, any money you receive later to cover those costs is not taxable.

Scenario B: You deducted your medical expenses and received a tax benefit.

If you previously itemized medical costs and received a tax deduction, the portion of your settlement that reimburses those expenses becomes taxable, up to the amount that reduced your tax bill.

Scenario C: You receive a settlement for future medical expenses.

Money meant to cover future treatment is not taxable, but you cannot later deduct those same expenses when you pay them.

For instance, suppose you had $15,000 in medical bills in 2024 and deducted $9,000 after accounting for the 7.5% of adjusted gross income rule. The following year, you receive a settlement that includes $15,000 to reimburse those bills. The $9,000 previously deducted now counts as taxable income on your next return.

Types of Non-Taxable Personal Injury Settlements

Personal injury settlements cover a broad range of cases, many of which fall entirely outside taxable income. Examples include:

• Motor vehicle accidents resulting in physical injury;
• Slip-and-fall or premises liability claims involving unsafe property conditions;
• Dog bites and animal attacks;
• Medical malpractice involving physical illness or injury;
• Workplace and construction accidents involving bodily harm;
• Product liability cases, such as defective vehicles or machinery;
• Dangerous drugs or medical devices; and
• Wrongful death claims filed by surviving family members.

In each case, the compensation addresses physical injury or its direct impact, so it is not considered taxable income under federal law.

What Else Should You Know About Taxes on Settlements?

The way a settlement is written and documented affects how taxes apply to your compensation. Key points to know:

1. Settlement Agreement Language

The written agreement should clearly state how damages are allocated, specifying which portion covers medical expenses, pain and suffering, or lost income. Clear language helps the IRS understand what qualifies as non-taxable compensation.

2. Documentation

Maintain copies of all medical bills, receipts, and prior tax returns showing whether you claimed medical deductions. Keep the settlement agreement and any correspondence about how the damages were categorized. This paperwork supports your filings and helps avoid disputes later.

3. Professional Advice

Before signing a settlement or filing a tax return that involves one, speak with both a personal injury attorney and a tax professional. A lawyer ensures the agreement is written in a way that minimizes tax exposure. A tax advisor confirms the correct way to report the income.

4. Plan for Interest and Punitive Awards

If your case includes punitive damages or accrued interest, consider setting aside a portion of the funds for taxes. Planning ahead prevents surprises and helps you keep track of what is truly yours to spend.

Contact Thorsnes Bartolotta McGuire About Your Personal Injury Settlement

Settlements are meant to help you rebuild your life, not create new financial worries. Knowing how taxes apply ensures you keep as much of your recovery as possible.

Thorsnes Bartolotta McGuire has represented injured people across California for 47 years, recovering over $2 billion in verdicts and settlements. Our attorneys handle every stage of a personal injury claim, from negotiating fair compensation to structuring settlements with tax efficiency in mind.

If you have questions about the tax implications of your case or need help pursuing compensation, contact us today. Call (619) 236-9363 or reach out online to schedule a free consultation.