IS PERSONAL INJURY SETTLEMENT TAXABLE?
In many cases, the answer to this question is no – a personal injury settlement is not taxable. IRS Code § 104 excludes from gross income those monies received in compensation for Personal Injury and Sickness. The intent of the code is that damages received from an injury are a replacement of a loss and are not a gain to the taxpayer.
IRS Publication 525 provides in part: Other compensation. Many other amounts you receive as compensation for sickness or injury are not taxable, including compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments. Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement.
However, there are some important exceptions to this general rule. For example, punitive damages and most emotional distress claims are not tax-free. Also, Reimbursement of lost wages is often taxable, as is any compensation you receive for a non-disclosure agreement.
The above information is a very generalized and basic answer to the question of whether a personal injury settlement is taxable – every case is different and requires individual analysis to know for sure. If you are involved in a personal injury case, you should consult your personal injury lawyer and an accountant before finalizing the settlement to make sure you understand the tax issues for your specific situation.