In most cases, the compensation you receive from a personal injury settlement is not taxable.
However, the full picture is more nuanced.
Certain portions of your settlement may be subject to federal and state taxes, depending on how the damages are categorized and what they are meant to address.
IRS Rules & Legal Basis
IRC Section 104(a)(2) states that damages received for personal physical injuries or physical sickness are generally excluded from gross income.
This means if you were hurt in a car accident, slip and fall, or similar incident, the compensation you receive for those physical injuries typically won’t be taxed.
That being said, the IRS emphasizes that facts and circumstances matter. Not every dollar in your settlement receives the same treatment.
How your settlement is structured—and how different types of damages are allocated—plays a role in determining what is taxable and what is not.
What Parts Are Generally Not Taxable
You can typically exclude compensation for medical expenses related to your physical injury, as long as you haven’t previously deducted those expenses on your taxes.
Pain and suffering, emotional distress, and other non-economic damages are also usually non-taxable when they are directly tied to a physical injury.
Additionally, recovery for property damage may be exempt if it is properly allocated in your settlement agreement.
What Might Be Taxable
While much of your settlement may be protected, certain categories are often subject to taxation:
- Punitive damages are always taxable because they are designed to punish the defendant rather than compensate you for losses.
- Interest on your settlement, whether accrued before or after the settlement date, is taxed as ordinary interest income.
- Emotional distress compensation becomes taxable when it is not connected to a physical injury.
- Previously deducted medical expenses may be taxable if your settlement reimburses any costs that you already claimed as deductions.
- Lost wages or income replacement are often treated as ordinary income, depending on the circumstances of your case.
Georgia State Tax Considerations
If you live in Georgia, you will need to consider state income taxes as well. The good news is that Georgia’s tax laws generally align with federal standards when it comes to personal injury settlements.
This means the same exclusions and taxable categories that apply at the federal level typically apply for your state return too.
Reporting and Practical Advice
Even when portions of your settlement are exempt from taxation, you still have to report the compensation to the government.
Taxable amounts are generally reported on Form 1040 under “Other Income.” To make this process smoother, keep thorough documentation of your settlement agreement, including how the damages were allocated.
This paperwork helps clarify which portions are taxable and which are not. For complex settlement structures or substantial amounts, consulting with a tax professional is a wise investment.
Personal Injury Taxes Can Be Complicated—Get Expert Help
Many personal injury settlements aren’t taxed, but some portions can be.
The key is understanding how different types of damages in your settlement are categorized and allocated.
Before you spend or plan around your settlement funds, review your agreement carefully. When in doubt, working with a qualified tax professional can help you navigate these complexities while keeping more of what you have rightfully recovered.