The tax consequences of a personal injury settlement depend on what the money is compensating you for. While much of it is non-taxable, certain portions can be taxed—and misunderstanding the rules could lead to an unexpected IRS bill.

Here’s a breakdown:

Non-Taxable Portions (Generally)

Under IRC Section 104(a)(2), the following are NOT taxed:

• Compensation for Physical Injuries or Physical Sickness

If you received money for:

• Medical bills (past or future)
• Pain and suffering due to a physical injury
• Emotional distress caused by a physical injury

✅ These are tax-free.

Example: You broke your leg in a car accident and receive $100,000 for medical costs and pain—not taxable.

• Out-of-Pocket Medical Expenses

As long as you didn’t claim those expenses as a deduction on your tax return in a prior year, your reimbursement is tax-free.

Taxable Portions

The following can be taxable, depending on your situation:

• Lost Wages or Lost Income.  If your settlement includes money to replace missed work income: This is usually taxed like regular wages.
• Emotional Distress (Not From Physical Injury).  If your emotional distress is not the result of a physical injury (e.g., workplace harassment without physical harm): This is taxable.
• Punitive Damages.  These are awarded to punish the defendant, not compensate you. Always taxable, even in personal injury cases.
• Interest on the Settlement.  If your settlement accrues interest (for example, from a delayed payment): That interest is taxable income.

How to Protect Yourself

• Get a breakdown of your settlement from your attorney (what part is wages, medical, pain, etc.).
• Work with a CPA or tax advisor who understands personal injury settlements.
• Use a structured settlement (where possible) to spread out taxable portions and reduce your yearly tax burden.

In Summary:

✅ Tax-Free Portions

These parts of a personal injury settlement are NOT taxable under IRS rules:

⚠️ Taxable Portions

These parts of a settlement may be taxed: