The short, quick and good news answer is that generally a personal injury settlement is not taxable to you!
That answer works for many personal injury settlement scenarios. But as lawyers are wont to do when answering a question, the more precise answer is that it depends. That’s because, as you might imagine, the IRS has something to say on the subject. And not surprisingly the devil is the details.
This means that the general answer is just that general, and so the specific answer will depend on the facts and circumstances of your case.
How your physical and mental injuries affect your settlement
Personal physical injuries: Settlements or awards that are received for your personal physical injuries or sickness are not taxable; that is, you don’t have to include any of that money as income on your return. There’s a caveat for those who itemize and in prior years took a deduction for medical expenses. In those cases, if you took a deduction for medical expenses that were related to your injury, you must include that portion of your settlement to the extent that the medical expense deduction provided you with a tax benefit. Details on how to calculate that amount are laid out in the “Recoveries” section of IRS Publication 525.
Emotional distress and mental anguish: To the extent the recovery for emotional distress or mental anguish originated from the personal injury, then you treat that portion of the recovery just as you would the recovery for the actual personal injury (see above).
If the emotional distress or mental anguish claim isn’t related to your personal injuries, that portion of your recovery needs to be included as income.
Again, there’s an exception that allows you to reduce the reportable amount by amounts paid for medical expenses incurred that are related to emotional distress or mental anguish. However, this is only if it was not previously deducted. (Or if it was previously deducted, it did not provide a tax benefit.)
How your financial losses impact your settlement
Lost wages or lost income: Lost wages or income are also generally not reportable in a personal injury situation. (By contrast, lost wages recovered as a result of wrongful termination or unlawful discrimination case are taxable.)
Punitive damages: In the more unusual situation where a jury also awards punitive damages, then that portion of your recovery is considered “other income” and needs to be reported.
A disclaimer on your settlement
I’ve been a practicing injury attorney for years; I’m not a tax attorney. My best advice (disclaimer) is for specifics about your personal injury settlement and your taxes, consult your tax adviser.