Do I Pay Taxes on Personal Injury Settlement?

Most personal injury lawyers answer the "Do I have to pay taxes on a personal injury settlement?" one of two ways:

  1. No, or
  2. I'm not a tax lawyer. You need to consult a tax lawyer to get an answer.

Both answers can be correct, but both are flawed. The first answer is true in the vast majority of personal injury cases. If this answer is applied to the facts of the case, then it may well be the correct answer. But as a general, abstract principle, it is incorrect to say that personal injury settlements are never taxed.

tax personal injury

The "go hire a tax lawyer" answer is the easiest answer to give. It completely gets the personal injury lawyer off the hook. It also has the benefit of being true. A tax attorney is the only way you can be sure of your answer. (Good time to note: you cannot rely on this page as tax advice. As it turns out, we are not tax attorneys either and, even if we were, you can never be certain that general advice applies to your case.)

But in the real world, people do not get definitive answers to every legal question they have. They try to get the best information possible. The purpose of this page is to give you the information you need to get a better understanding of the issues. It is, to beat a dead horse, certainly not legal advice you can rely upon with certainty. But then, maybe you call a tax lawyer and ask for a quick answer to a specific question that she hopefully provides for free or for a small charge, or you make the best call that you can based on the research that you have done.

Which Tax Code is Applicable?

The IRS helpfully informs us that “all income is taxable from whatever source derived, unless exempted by another section of the Code” (IRC Section 61).

Thankfully, there is an exception in most personal injury cases. The most relevant IRS regulation on whether personal injury settlements and verdicts can be taxed is 26 C.F.R 1. It states, in pertinent part:

§1.104-1 Compensation for injuries or sickness.

(c) Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross 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. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.

Compensation for Medical Expenses and Pain and Suffering

In the vast majority of our cases, pain and suffering and medical bills make up the vast majority of the claim if not the entire claim. This is true not only in injury cases but in wrongful death claims where the damages are, more often then not, limited to the wrongful death pain and suffering claims and the victim's estate's claim.

There is just one word or caution on this. If you claimed a medical expense deduction for costs that are ultimately reimbursed through a verdict or settlement, the IRS requires that you “recapture” the previously deducted amount by reporting it as income.

Property Damage Generally Not Taxable Either

Property settlements are generally not taxable. The IRS says that if the loss in value of the property is less than the adjusted basis of your property, then it is not taxable although you must reduce your basis in the property by the amount of the settlement (if you are amortizing the property for tax purposes). So if the settlement exceeds your adjusted basis in the property, the excess is income. It is the same "recapture" issue we just talked about above.

Confused? Understandably. But let's assume for a second this is not an asset you are depreciating on your taxes but just a car that you own for your own personal use. Assuming you got a check that fairly compensates you for the loss, you are unlikely to be in a position where you are paying taxes on your property damage settlement check.

Compensation for Lost Income or Lost Business

In personal physical injury cases, any portion of the recovery for lost wages is not subject to income tax. See 26 U.S.C. § 104(a)(2) and Commissioner of Internal Revenue v. Schleier, 515 U.S. 323, 329-30 (1995).

What if the injuries are purely emotional? If we ever fire out the "call a tax lawyer" response, this is it. Our firm handles physical injury cases only. So this is far from our wheelhouse. But, in these cases, any settlement or verdict for lost wages or lost business income is subject to federal income tax.

Confidentiality and Non-Disparagement Settlement Clauses

A confidentiality clause prohibits the parties to a settlement from disclosing the settlement terms and/or details about the case. You know what a non-disparagement clause is: you keep your negative comments to yourself as a part of the deal. The IRS concluded -- in a case involving Dennis Rodman of all people -- that this portion of a settlement is taxable. This is clearly a bigger deal in the Rodman case than a garden variety personal injury settlement. But this is still an important thing to keep in mind.

Punitive Damages and Interest

Maryland has a very high standard for punitive damages such that our law firm has never made a successful claim for punitive damages. So it is not an issue we often face. But it is correct to say that punitive damage awards are taxable.

Pre-judgment interest and post judgment interest are taxable. In Maryland, we do not have pre-judgment interest in personal injury cases except uninsured motorist cases which are rooted in contract. But these insurance companies love to appeal verdicts and the interest on those verdicts is subject to federal taxation.

Getting Help from a Lawyer

If you need a tax lawyer, you should not be calling Miller & Zois. But if you have a personal injury or medical malpractice case in Maryland, call one of our lawyers at 800-553-8082. You can also get a free no obligation case review consultation.

More Information
  • What the IRS specifically tells us on personal injury settlements
  • I like he answer on the tax issue. Now help be better understand how much my personal injury case is worth.

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