Are Personal Injury Settlements Taxable?
The short answer
For most people hurt in a crash or a fall, most of the settlement is not taxable income. Federal law excludes from income the damages you receive “on account of personal physical injuries or physical sickness” (26 U.S.C. § 104(a)(2)). California generally follows the federal rule for state income tax.
That covers the main parts of a typical physical injury case:
- Medical bills, past and future
- Pain and suffering
- Lost wages, when they come from the physical injury
- Emotional distress that comes from the physical injury
The exclusion depends on why the money was paid, not what it is called. A settlement paid because you were physically hurt is in a different position from one paid for something else.
The parts that can be taxed
- Punitive damages. Money meant to punish the defendant is not excluded, even in a physical injury case. Punitive damages are uncommon in settlements, but they come up.
- Interest. Interest paid on a judgment or a settlement is generally taxable, even when the damages themselves are not.
- Medical expenses you already deducted. If you deducted medical bills on an earlier tax return and the settlement later repays them, the repaid part can be taxable.
- Emotional distress without a physical injury. When the claim is only for emotional distress, the damages are generally taxable, except for the part that pays medical costs for treating that distress.
- Claims that are not about a physical injury. Settlements in employment cases, for lost profits in a business dispute, or for a purely financial loss follow different rules.
Property damage
Money for a damaged or totaled car usually is not income, because it repays you for what you lost rather than making you better off. Read what fair value means when your car is totaled.
Why the settlement paperwork matters
How a settlement agreement describes the payment can matter later, if the IRS ever asks what the money was for. In a case with both physical injury damages and something that could be taxable, the agreement should say what was paid for what. That is something to raise before the agreement is signed, not after.
This is general information
Every case is different, and tax law has exceptions this post does not cover. Talk to a CPA or tax professional about your own settlement, especially if it includes punitive damages, interest, or a business loss. Boyd can tell you what the settlement pays for. Your tax professional tells you how to report it.
Read what a medical lien is for the other thing that affects what you take home.
Talk to Boyd
If you have questions about a settlement offer, call. The consultation is free, and Boyd takes the call himself: (714) 656-2400.