Tax implications are factored in when determining whether to settle or take a personal injury claim to trial. Damages and settlement awards from personal injury suits usually comprise of tax-free compensatory damages for physical injury or illness. However, there are certain damages and settlement awards that are not tax-free. How proceeds are characterized determines the amount of tax a litigant must pay. Settlements provide more control over the characterization of proceeds, since the parties can negotiate allocations. If the case goes to trial, the judge or jury characterize the proceeds.

Damages and Settlement Awards for Physical Injury or Illness

In general, proceeds for personal injuries or physical illness are not taxed by the federal government or state taxing authorities. Awards for medical expenses are also non-taxable, unless the litigant took an itemized deduction for medical expenses in a prior year. For instance, if the litigant was injured in a car accident in 2015 and awarded $100,000 for medical expenses in 2016, the $100,000would not be taxable. However, if the litigant took an itemized deduction of $100,000 in 2015 for medical expenses, he or she would need to report the $100,000 to the Internal Revenue Service (IRS).

Damages and Settlement Awards for Emotional Distress

Emotional distress compensation may be non-taxable if the distress originated from a physical injury or illness. For instance, if the litigant was injured in a car accident and suffered emotional distress while in recovery, compensation for that emotional distress would be non-taxable. If the emotional distress was not caused by a physical injury or illness, then it would be taxable. The same rule for medical expense deductionsapply.

Lost Wages or Lost Profits

Compensation for lost wages or lost business profits is usually taxable as compensation for taxable income. In personal injury suits, however, compensation for lost wages or business profits are not taxable. The lost wages or lost business profits must related to a physical injury or illness to receive non-tax treatment.

Loss in Property Value

If damages or a settlement award compensates for a loss in property value, it is not taxable. For instance, compensation for a damaged vehicle would not have to be reported to the IRS. However, if the property settlement exceeds the property’s adjusted basis (the purchase price with tax adjustments), then the excess is reportable income.


If a portion of a settlement or award is for interest, it is treated as “interest income” and is taxable. It is important to note that many state courts will add interest to award amounts for the time period the case was pending.

Punitive Damages

Punitive damages are usually considered taxable income, even if awarded to compensate for physical injury or illness. Punitive damages are amounts paid to punish the opposing party for wrongdoing. If punitive damages are awarded at trial, the attorney will ask the judge or jury to allocate the award between compensatory and punitive damages.

Are Attorney Fees Deductible in Personal Injury Cases?

Awards for attorney fees are taxable, but attorney fees may be deducted from the taxable portion of the proceeds. For instance, say the litigant was awarded $200,000, $100,000 in compensatory damages and $100,000 in punitive damages, and the attorney’s fee was 40% of the proceeds. The litigant may only deduct$40,000 from the portion awarded for punitive damages, since that portion is taxable.

Attorney fees are also treated as miscellaneous itemized deduction items, and thus, cannot be deducted if the standard deduction is taken. Itemizing deductions is only advantageous if all of the taxpayer’s deductions are greater than the standard deduction. In 2015, the standard deduction for single taxpayers was $6,300.  A litigant should only deduct attorney fees if their deductible items are more than the standard deduction.

Can a Personal Injury Award Increase Your Tax Rate?

Tax rates are another consideration when characterizing settlement awards. Taxable compensation, such as punitive damages and interest, is taxed as ordinary income. This means that the award is added to other ordinary income, such as wages, and could push the litigant into another tax bracket and increase their tax rate.

Should I Speak to a Tax Attorney?

For the tax-conscious litigant, settlement negotiations provide more control over the characterization of proceeds. It you have filed a personal injury claim, speaking with a tax attorney could optimize your tax consequences.