Is a personal injury settlement taxable?

Once you finally receive your injury settlement, you can get started on piecing your life back together. However, the upcoming tax season might leave you concerned that Uncle Sam will take a percentage of your personal injury awards. 

Is a personal injury settlement taxable? More importantly, you are most likely thinking, “Is my personal injury settlement taxable?”

For the most part, the answer is no. On the federal and state levels, settlements or verdicts from a personal injury case are not taxable. This is true no matter the amount.

However, there are some special cases where either a portion of the settlement or the entire amount can be taxable. We’ll take a look at those below.

Knowing what parts of your settlement are tax-exempt helps you maintain as much of your payout as possible.  But if you have questions, you can always seek legal advice. Learn how a personal injury lawyer can help you. And to help you find an attorney to consult, start with our free search tool by entering your ZIP code.

What Is Not Taxed in an Injury Claim

The IRS typically does not tax proceeds from a personal injury settlement. This stance is based on the condition that the proceeds were directly related to your personal injury. That means that the following should not be included as income:

#1 — Medical Bills

Any compensation you receive for your medical bills is tax-exempt. This also includes any ongoing medical treatment you will need in the future. The only exception is if you deducted medical expenses in previous years. In that case, you would take a portion of your settlement for medical costs and include that as taxable income. 

#2 — Property Damage

For those involved in a car accident, it’s important to note that the compensation you receive to repair your vehicle is tax-exempt. This includes paying for a rental car while your car is being repaired. 

Read more:

• What To Do Immediately After a Car Wreck
• How to File Personal Injury Claims After a Car Accident

#3 — Pain & Suffering Related to Your Injury

Any compensation for mental and emotional damage done as a direct result of your accident will be tax-exempt.  To avoid taxes on your pain and suffering awards, you must have visible injuries like broken bones or bruises. 

#4 — Sickness or Illness

A personal injury case that involves a plaintiff getting sick through the fault of another is still considered a physical injury. So it is not taxable.

Other Nontaxable Insurance Claims

Depending on the nature of your accident, you may be required to file different types of claims. 

Here are a couple of claims that are also tax-exempt.

Workers’ Compensation Claims

When injured workers collect workers’ compensation benefits due to an accident or injury, they won’t have to worry about taxes either. This principle also extends to any surviving family members if an employee dies. 

However, there is one exception to workers’ compensation claims. Suppose an employee receives both social security disability and workers’ compensation benefits. In that case, the amount received from social security disability will be taxed. 

Wrongful Death Claims

Surviving family members may pursue a wrongful death claim against the at-fault party when a loved one dies due to another’s negligent actions. Any compensation received in the final settlement is considered tax-exempt. 

Life Insurance Proceeds

If you are the primary beneficiary on a life insurance policy, any proceeds you receive from the death of a loved one will be tax-exempt. The IRS states that any interest you receive on life insurance proceeds is taxable income. Learn more about What is a Life Insurance Beneficiary?

What Is Vulnerable to Taxation in a Settlement

A lot goes into determining the total value of your injuries and losses. This can result in a substantial settlement depending on your case. Although the IRS doesn’t typically interfere with your personal injury awards, there can be personal injury settlement taxes.

To answer questions such as “Do you have to pay taxes on personal injury settlements?” and “Is a personal injury settlement considered income?”, here are some taxable items:

#1 — Punitive Damages

Are punitive damages taxable? Punitive damages differ from your average compensatory damages like medical bills and pain and suffering. Punitive damages are awarded when the plaintiff proves that your injuries were caused by the defendant’s reckless disregard for the safety of others. These damages punish the at-fault party. Although they are rarely awarded, punitive damages will always be taxed. 

#2 — Lost Wages

Are personal injury settlements taxable when they include lost wages? In business law cases regarding unlawful termination and other instances, lost wages are usually taxed. However, your award for lost wages in a personal injury case may also be subject to taxation. This is based on the fact that if you had not been injured, you would have included your earned wages as income anyway.

#3 — Medical Expenses Deductions Before Settlement

Any deductions you made for medical expenses before your case was settled would be taxable once the settlement is paid. So if you deduct medical expenses in the year(s) prior to the settlement, you would need to pay taxes on that amount.

#4 — Accrued Interest

Another situation where you may be taxed on a portion of the settlement is if there was a lengthy appeals process that held up the payment of the settlement. In this case, interest would be accrued as the case continued. When the settlement is ultimately reached, it will include the interest accrued.

This interest would be taxed, as it’s not part of your actual settlement and is instead more like an investment return.

#5 — Emotional Only Claims

As stated above, pain and suffering resulting from an injury is tax-exempt. However, you must have visible injuries to receive nontaxable awards for your mental anguish. Any compensation you receive from emotional distress alone is taxable.

Emotional injuries, for example, are still fully taxable. So if your injuries were all emotional and there was no physical injury, you would need to pay taxes on the full amount of that settlement or verdict.

One thing to note though. Many times a settlement will have two components or more. So there may be physical injury and emotional injury. In this case, a competent lawyer will try to separate these two amounts to lessen the tax burden of having to pay the full amount.

This may all sound complicated, but in general, all physical-related settlements are non-taxable. Any payout or portion of a payout related to non-physical injuries — pain and suffering, for example — is taxable.

#6 — Breach of Contract

Sometimes a personal injury case will involve a breach of contract dispute of some kind. If the breach of contract is central to your personal injury case and was the main factor for your injuries occurring, then settlements or verdicts would be taxable. See our article When Does a Breach of Contract Occur?

This would also include things like lost wages or other penalties that were a result of the breach of contract.

#7 — Attorney Fees

Any reimbursement you receive for your attorney fees in your final settlement will be considered taxable income. The exception is only for employment discrimination cases and whistleblower rewards where all attorney fees are tax-exempt. 

Taxation Whether the Case Was Settled or Needed to Go to Trial

Many people mistakenly believe that if a personal injury case is settled, you will need to pay taxes since no actual injury was proven in court.

This is not true. It does not matter if you settle on the first day of bringing the lawsuit or on the last day before a verdict is read. If it was a personal injury case that was originally brought, it is not taxable.

This also includes if the case went to trial and there was a verdict in your favor. It is still not taxable if it were for physical injuries.

Why Some Settlements Are Taxed and Some Are Not

This is difficult to answer as there are many factors involved. In general, personal injury settlements are not taxed because they are seen as a reimbursement.

Say for instance you were injured and it cost you $10,000 to pay for medical treatments or copays for your health insurance. If you were awarded $10,000 in a settlement, that would be a reimbursement. Regarding taxes on $10,000 settlement, it would seem illogical to tax someone on money that was meant to repay a bill. Therefore, all physical injury costs are not taxable in most cases.

How Much Your Final Settlement Will Be Taxed

Unfortunately, there is no concrete answer to this question. The amount you will be taxed depends on many factors like your salary and how much of your settlement is considered taxable income. 

How to Maximize Your Injury Settlement

When pursuing personal injury compensation, the goal is obvious: fight to receive as much as you can. This involves knowing what battles to fight and what ones to avoid. Relentlessly pursuing a fair settlement for your medical bills may be more beneficial than punishing the at-fault party for taxable punitive damages.

Understanding what parts of your claim will be taxed can help you be more strategic when negotiating a settlement. 

Talk With Your Lawyer About These issues if You Have Questions

As your case approaches settlement talks or a trial, you can ask your attorney about the tax implications of how the structure of your requested settlement impacts that.

Generally, your lawyer will attempt to structure the settlement in a way that lessens the tax burden. Sometimes this is not entirely possible though. Still, it’s a good idea to at least discuss this aspect with your lawyer before settlements or verdicts are reached.

Once you do receive your personal injury settlement, you will then need to consult a tax professional, since they are up-to-date on tax law. Once the settlement is made and the money transferred, it is now a tax issue, and your personal injury lawyer can most likely not provide advice on that topic.

As mentioned, a personal injury case is not something we ever want to be involved in. They can be stressful and painful and can take years to finally reach a resolution. However, thankfully we have these tools available so those who have suffered injuries can at least be financially compensated for their injuries and other losses — generally without an additional tax burden.

So now you should be much better informed on personal injury lawsuit settlement taxes, so you can avoid taking the time to do an online search on “is personal injury settlement taxable” or “are injury settlements taxable.”

However, if you still have specific questions about taxes on settlements for personal injury, make sure to consult your attorney or tax professional. Need to find a lawyer? Simply enter your ZIP code below to start your search.

Case Studies: Taxability of Personal Injury Settlements

Case Study 1: The Smith Family vs. Guardian Insurance Company

The Smith family filed a personal injury claim against Guardian Insurance Company following a car accident caused by one of their insured drivers. The court awarded them a $100,000 settlement for medical expenses, lost wages, and pain and suffering. The Smith family sought guidance to their question, “Do you have to pay taxes on personal injury settlements?”

After consulting with tax experts, it was determined that the settlement was entirely non-taxable. The entire amount was allocated to cover medical expenses and compensate for pain and suffering, which are generally considered non-taxable under the current tax laws.

Case Study 2: John Davis vs. Liberty Insurance Corporation

This is a case in which the answer to “Do personal injury settlements get taxes?” is yes to one part of it. John Davis, an employee of a construction company, suffered a severe back injury while working on a construction site due to the negligence of a subcontractor. After filing a personal injury claim against Liberty Insurance Corporation, the court awarded him a settlement of $500,000 to cover medical bills, lost wages, and future rehabilitation costs.

The settlement in this case was divided into categories. The portion for medical bills and lost wages was deemed non-taxable, but the portion for future rehabilitation costs was considered taxable. Since future medical expenses could potentially replace income, they were subject to taxation.

Case Study 3: Sarah Johnson vs. Secure Insurance Group

This is also a case in which the answer to “Are insurance settlements taxable?” is yes to one part of it. Sarah Johnson, a pedestrian, was struck by a vehicle insured by Secure Insurance Group. As a result of the accident, Sarah suffered a severe leg injury and incurred substantial medical expenses. The court awarded her a settlement of $200,000 to cover medical bills, pain and suffering, and ongoing physical therapy.

Upon review, the settlement was found to have a non-taxable portion for medical bills and pain and suffering. However, the amount designated for ongoing physical therapy was taxable. The ongoing nature of the therapy indicated potential future income replacement, leading to its taxability.