The rule for physical injuries
Federal law excludes from income damages received “on account of personal physical injuries or physical sickness” (26 U.S.C. § 104(a)(2)). That covers medical expenses, lost wages and pain and suffering in a typical injury claim, as long as they flow from a physical injury.
What is usually taxable
| Part of the settlement | Federal tax treatment |
|---|---|
| Compensation for a physical injury or illness | Not taxable |
| Emotional distress from a physical injury | Not taxable |
| Emotional distress without a physical injury | Taxable, except amounts paid for related medical care |
| Back pay and lost wages in an employment claim | Taxable as wages |
| Punitive damages | Taxable |
| Interest on a judgment or settlement | Taxable |
Deducted medical expenses
If you deducted medical expenses in an earlier year and the settlement repays them, that part can be taxable. Keep records of what you deducted.
Wording matters
How the settlement agreement allocates the money between categories affects the tax result. Talk to a tax professional before you sign, not after.
Questions people ask
Are car accident settlements taxable?
Usually not, because they compensate a physical injury. Interest and any punitive damages are taxable.
Do I pay tax on a wrongful death settlement?
Compensatory damages for a death caused by physical injury are generally not taxable. Punitive damages are.