Are personal injury settlements taxable?

What the law says

Section 104(a)(2) of the Internal Revenue Code excludes from income “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.” Three phrases do most of the work:

• “Any damages” — not just medical bills. Lost wages and pain and suffering that flow from a physical injury are covered too. IRS Publication 4345 puts it simply: if you didn’t deduct the related medical expenses in earlier years, “the full amount is non-taxable.”
• “Other than punitive damages” — punitive damages are taxable even in a physical injury case.
• “Physical” — emotional distress counts only when it comes from a physical injury or sickness.

What’s usually tax-free in an injury settlement

• Medical expenses you didn’t deduct on an earlier tax return.
• Lost wages caused by the physical injury. (Back pay in an employment lawsuit is different — it’s taxable wages.)
• Pain and suffering, and emotional distress or mental anguish that stems from the physical injury.
• Property damage, such as repairs to your car, as long as the payment isn’t more than your adjusted basis in the property. You reduce your basis by the amount you receive.

What can be taxed

• Punitive damages. Taxable and reported as other income, even when the case is about a physical injury. The one exception is a wrongful death action in a state whose law allows only punitive damages in such cases.
• Interest on a settlement or judgment, reported as interest income.
• Medical expenses you already deducted. If you itemized and deducted injury-related medical bills in an earlier year, the part of the settlement that reimburses them is income to the extent the deduction lowered your tax. IRS Publication 525 explains how to figure it.
• Emotional distress without a physical injury. Taxable, reduced by the medical costs for that distress that you didn’t deduct before.
• Property damage above your basis. The excess is income.

Example: a $60,000 car accident settlement

An illustrative settlement, broken down the way the agreement allocates it:

In this example $55,000 is tax-free. The $5,000 that may be taxed comes from two places: the interest, and the medical bills that were already deducted on an earlier return.

Taxes on a $10,000, $50,000, $100,000 or $500,000 settlement

The amount doesn’t decide the tax — what the money is for does. If the whole settlement compensates a physical injury, the federal income tax is zero whether it’s $10,000 or $500,000. The last two columns show the other end: what the federal tax would be if the entire amount were taxable, for example punitive damages or an emotional distress claim with no physical injury.

Illustrative. The “all taxable” figures assume a single filer who also earns $60,000 in wages and takes the $16,100 standard deduction, using the 2026 federal rate table (Rev. Proc. 2025-32). They’re the extra tax the settlement adds on top of the tax on the wages, figured on the full amount before attorney fees (see attorney fees and taxes). State income tax, credits and other income aren’t included. Real settlements are usually a mix: only the taxable parts — interest, punitive damages, medical bills you already deducted — fall in the last two columns.

State income tax on an injury settlement

Most states with an income tax start from your federal adjusted gross income. Money excluded under section 104 never enters federal adjusted gross income, so those states begin without it. Pennsylvania is the main exception: it has its own definition of income, and its rules differ from the federal ones in both directions.

Every state adjusts its starting point with its own additions and subtractions. If part of your settlement is taxable federally, or you live in a state not listed here, check your state tax agency’s instructions or ask a tax professional.

Why the settlement agreement’s wording matters

Many settlement agreements allocate the payment among different claims — medical expenses, lost wages, emotional distress, property damage. According to IRS Publication 4345, “the IRS will not disturb an allocation if it is consistent with the substance of the settled claims.” In other words, the allocation should reflect what the case was actually about. If your claim includes something that can be taxed, such as punitive damages, ask your attorney how the agreement allocates the payment before you sign.

Attorney fees and taxes

For a tax-free physical injury settlement, the attorney’s fee doesn’t change anything — the whole recovery is excluded. It matters when part of the recovery is taxable. In Commissioner v. Banks (2005), the Supreme Court held that when a recovery is income, the litigant’s income generally includes the portion paid to the attorney as a contingent fee. Whether you can deduct that fee depends on the type of claim and current tax rules, so this is a question for a tax professional.

Will you get a 1099?

Under the IRS instructions for Form 1099-MISC, payers don’t report damages received on account of physical injuries or physical sickness, other than punitive damages. Punitive damages and other taxable damages are reported — punitive damages even when they relate to a physical injury. If the settlement is paid through your attorney, the payer may also issue a 1099-MISC to the attorney for the gross amount. A 1099 doesn’t decide whether something is taxable; the nature of the payment does.

If part of your settlement is taxable

1. Find the allocation in your settlement agreement and your final settlement statement.
2. Report interest as interest income, and punitive damages or other taxable damages as other income.
3. If you deducted injury-related medical expenses in an earlier year, work out the recovery amount using IRS Publication 525.
4. If you expect to owe $1,000 or more after withholding and credits, you may need to make estimated tax payments.
5. If you get health coverage through the Marketplace with advance premium tax credits, a taxable settlement can change your income — report the change.

This page covers federal income tax and, in the table above, the starting point of seven states. State rules can differ in the details; check with your state’s tax agency or a tax professional.