- Generally, personal injury settlement proceeds are not taxable if they are received for physical injury.
- Settlement proceeds received for mental anguish, lost wages, and other harms not related to physical injuries (e.g. employment discrimination claims) are generally taxable as regular income.
- For formal tax advice, see your professional tax advisor.
Our clients often wonder whether the money they receive in a personal injury settlement or employment discrimination case settlement will be taxable income. Like so many legal questions, the answer is. . . it depends.
Each case has different factors, and some of your previous tax filing decisions can affect the taxability of settlement proceeds, so you need qualified legal counsel and tax advice anytime you have a potential personal injury claim. You certainly don’t want to end up on the wrong side of the IRS.
With all that said, a good rule of thumb is that when you receive funds that are intended to pay you back for personal physical injuries (including medical treatment, pain and suffering), that money is not taxable. Other settlement money, such as that received from employment discrimination and business dispute settlements, might be taxable if it doesn’t relate directly to an actual physical injury that you suffered. These types of damages can include lost wages, damage to reputation, and punitive damages. The key here, as you see, is how the damages are characterized. Sometimes, we have control over that issue in crafting our settlement demands and settlement documents.
Most importantly, the tax questions that arise from settlements in personal injury claims, employment discrimination claims, and business disputes are complicated and require competent legal counsel and tax advice. The earlier you get that advice and counsel, the better off you are. This is just one more reason that we always advise you to call as soon as you think you may have a claim or lawsuit.