Q Is my personal injury settlement taxable?
In almost all personal injury cases, the settlement or jury award is not taxable for purposes of federal or state income tax. The tax code says that any amounts recovered for a physical injury are not income. This includes amounts paid for lost wages, medical bills, emotional distress, pain and suffering, attorney fees, and other related harms and losses.
The rationale is that this money is not income, but is the result of a loss. These funds only make the person whole. It is easier to see how this applies in another setting. For example, when the person receives a check for damage to the car involved in an accident, these funds are not income. The same reasoning applies when a person sustains bodily injuries due to someone's negligence.
A different rule applies if the person injured did not sustain any physical injury, but only emotional injuries. In those cases, the settlement or judgment is taxable. These cases include claims for employment discrimination, negligent infliction of emotional distress, or defamation.
If a person recovers punitive damages, punitive damages are taxable. Punitive damages are damages in excess of what is necessary to make a person whole. These damages are designed to punish the defendant and serve as a deterrent to further similar conduct in the future. However, compensatory damages (the actuall losses sustained) are not taxable.