Last reviewed: October 2026 · How we research: How We Research
Short answer: if your settlement compensates you for a physical injury or physical sickness, it is generally not taxable under federal law, and that includes the part for lost wages and pain and suffering. What usually is taxable: punitive damages, interest, emotional distress damages without a physical injury, and repayment of medical costs you already deducted. How your settlement agreement allocates the money matters, so read this before you sign.
The rule: IRC Section 104(a)(2)
Section 104(a)(2) of the Internal Revenue Code excludes from income “damages (other than punitive damages) received … on account of personal physical injuries or physical sickness”, whether by lawsuit or settlement, and whether paid in a lump sum or over time. The IRS applies it based on what the payment was for: the “origin of the claim”. If the claim exists because you were physically hurt, the compensatory damages flowing from it are generally tax-free, even the part measured by your lost wages.
What’s taxable and what isn’t
| Part of the settlement | Federal income tax |
|---|---|
| Medical expenses (physical injury) | Not taxable, unless you deducted them in an earlier year |
| Pain and suffering (physical injury) | Not taxable |
| Lost wages (physical injury case) | Not taxable |
| Emotional distress with no physical injury | Taxable, except amounts that reimburse medical care for it |
| Punitive damages | Taxable (narrow wrongful-death exception) |
| Interest on the settlement or judgment | Taxable |
| Property damage (e.g. your car) | Not taxable up to your adjusted basis in the property |
Sort your own settlement
Settlement tax sorter
Enter how your settlement is allocated (your settlement agreement or lawyer can tell you). Leave unused lines at 0.
Federal income tax only, simplified. Not tax advice; confirm with a tax professional.
Three real-life scenarios
1. A car accident settlement for a broken leg
Mike receives $75,000 for medical bills, four months of lost wages and pain and suffering after a crash. All of it stems from a physical injury, so none of it is federal taxable income, including the wage portion. He didn’t deduct his medical bills in a prior year, so nothing needs to be added back.
2. A judgment with interest
Rosa wins $120,000 at trial for a slip-and-fall injury, and because payment came months later, the defendant also pays $6,000 of post-judgment interest. The $120,000 is excluded; the $6,000 of interest is taxable, and she may receive a Form 1099-INT for it.
3. A drunk-driving case with punitive damages
Tom receives $200,000 in compensatory damages and $50,000 in punitive damages. The compensatory part is excluded; the $50,000 of punitive damages is taxable, even though the case is about a physical injury.
The details people miss
Medical expenses you already deducted
If you itemized and deducted injury-related medical expenses on a previous return, and the settlement later reimburses them, that reimbursement is taxable to the extent the deduction reduced your taxes (the “tax benefit rule”). Most people don’t itemize medical costs, so this rarely applies, but check.
Emotional distress
Emotional distress caused by a physical injury (anxiety after a crash, for example) is part of the physical injury claim and excluded. Emotional distress without a physical injury, as in many employment or defamation cases, is taxable, except for the amount that pays for medical treatment of that distress, such as therapy.
Attorney fees
For a fully tax-free physical injury settlement, the fee question doesn’t arise. But for the taxable parts, the Supreme Court has held that you’re generally taxed on the gross amount, including the share paid to your lawyer, and most individuals currently can’t deduct those fees, apart from specific exceptions such as certain employment discrimination and whistleblower claims. This is one reason the allocation in the settlement agreement matters.
Property damage
Payment for damage to your car or other property is generally not income up to your adjusted basis in the property (usually what you paid, adjusted over time). It reduces your basis instead. Only a payment above your basis would be a taxable gain, which is uncommon for cars, since they lose value.
Structured settlements
Periodic payments for a physical injury are excluded too, including the growth built into the payments, as long as the structure is set up properly. Taking a lump sum and investing it yourself means future investment earnings are taxable.
Frequently asked questions
Will I get a 1099 for my settlement?
Payers generally don’t issue a Form 1099 for damages excluded as physical injury compensation. You may receive one for taxable parts such as interest (1099-INT) or punitive damages (1099-MISC). If you receive a 1099 you believe is wrong, ask the payer to correct it and keep your settlement agreement.
Do I have to report a tax-free settlement on my return?
Excluded physical injury damages generally don’t need to be reported as income. Taxable portions must be reported. Keep the settlement agreement and closing statement with your tax records.
Are settlements taxed by my state?
Most states follow the federal treatment, but check with a tax professional in your state, especially for punitive damages and interest.
Tax checklist before you sign
- ☐ The agreement states that the payment is “on account of personal physical injuries or physical sickness”.
- ☐ Any punitive damages or interest are listed separately, so the rest isn’t questioned.
- ☐ You know whether you deducted any of these medical costs in past years.
- ☐ For a large or mixed settlement, a tax professional has reviewed the wording before you sign.
Want to see what you’ll take home after fees and liens? Use our settlement take-home calculator.
Sources
- 26 U.S.C. § 104, Compensation for injuries or sickness (Cornell LII)
- IRS Publication 4345, Settlements: Taxability
- IRS, Tax implications of settlements and judgments
- Commissioner v. Banks, 543 U.S. 426 (2005): attorney fees included in the taxpayer’s gross income.
This guide is general information, not tax or legal advice. Tax treatment depends on the facts of your claim and the wording of your settlement agreement. Consult a qualified tax professional before signing a settlement.