Are Settlements Taxable? Injury, Lawsuit and Job Settlements

Some settlements are taxable and some are not. Under federal law it depends on what the money pays you for. Compensation for a personal physical injury or physical sickness is generally not taxable. That includes the parts for pain and suffering, medical bills and lost wages. Settlements for job claims, defamation, emotional distress without a physical injury, or business losses are generally taxable.

Punitive damages and interest are taxable even in an injury case. When a recovery is taxable, the share your lawyer keeps as a contingent fee is usually still counted as your income. The sections below go through each part of a settlement, the attorney-fee problem, the forms you may receive, and a few state differences.

Information last verified on October 24, 2026. This article has not been reviewed by a licensed lawyer.

Is this settlement taxable?

In a physical-injury case, the parts of a settlement are generally treated like this under federal law:

• Physical injury and pain and sufferingNot taxable26 U.S.C. § 104(a)(2)
• Medical expenses repaidNot taxable26 U.S.C. § 104(a)(2)
• Lost wages from the injuryNot taxableH.R. Conf. Rep. No. 104-737 (1996)
• Emotional distress caused by the injuryNot taxableIRS Publication 4345
• Punitive damagesTaxable other incomeIRS Publication 4345
• Interest (prejudgment or post-judgment)Taxable interestIRS Publication 4345

An estimate of general federal rules, not tax advice. How your agreement allocates the payment, the year you receive it, and your full return change the answer.

Estimate the tax on your settlement

Rules checked against IRS and U.S. Code sources on October 24, 2026. Rates: 2026 tax year.

The basic rule: what was the settlement meant to replace?

Federal tax law starts from the position that gross income means all income from whatever source derived. Settlement and judgment money is income too, unless a specific rule in the tax code excludes it.

The IRS frames the question this way: what was the settlement, and each payment in it, intended to replace? Money that replaces wages is generally taxed like wages. Money that replaces a business's lost profits is taxed like business income.

The one large exclusion is 26 U.S.C. § 104(a)(2). It covers damages, other than punitive damages, received on account of personal physical injuries or physical sickness. It applies whether the money comes from a lawsuit or an agreement, and whether it is paid as a lump sum or as periodic payments.

So the honest answer to "is a settlement taxable" is that one settlement can be partly taxable and partly not. The rest of this page goes through it piece by piece. To run your own numbers, use the settlement tax calculator.

Which parts of a settlement are taxable

This table shows the general federal income-tax treatment for the three most common kinds of case. It matches the treatment the calculator applies. Your agreement and your facts can change any cell.

One exception runs through every column: medical costs you already deducted on an earlier return come back into income to the extent the deduction gave you a tax benefit.

Are personal injury settlements taxable?

Compensatory damages for a personal physical injury or physical sickness are generally not taxable under federal law. IRS Publication 525 says not to include in income compensatory damages for personal physical injury or physical sickness, whether received in a lump sum or installments. That covers the usual car accident, slip and fall, dog bite, medical malpractice or product injury case.

Lost wages in an injury case

Some articles say the lost-wage part of an injury settlement is taxable. For a physical-injury case, that is not what the IRS says. When Congress added the word "physical" in 1996, it explained that if an action has its origin in a physical injury or physical sickness, all damages other than punitive damages that flow from it are treated as received on account of that injury.

The IRS's own summary of Rev. Rul. 85-97 says the entire amount of a personal-injury settlement from an accident, including the portion allocable to lost wages, is excludable. The same conference report language applies even when the person receiving the damages is not the injured party, such as a family member whose claim flows from the injury.

Emotional distress that comes from the injury

Emotional distress damages are treated the same as the injury itself when the distress is attributable to a physical injury or physical sickness. IRS Publication 4345 says the same thing about emotional distress or mental anguish attributable to a physical injury.

Medical expenses you already deducted

There is one catch on medical bills. The exclusion does not cover amounts attributable to medical expense deductions you took in an earlier year. IRS Publication 4345 says to include that part of the settlement in income to the extent the deduction provided a tax benefit. If you never itemized medical costs, this usually does not come up.

Wrongful death settlements

Compensatory damages in a wrongful-death case remain excludable. The 1996 conference report says damages other than punitive damages received on account of a claim of wrongful death continue to be excludable. Punitive damages in a wrongful-death case are the subject of the narrow exception covered next.

Structured settlements

The physical-injury exclusion applies whether the money is paid all at once or as periodic payments, because § 104(a)(2) says so in its text. Selling future structured payments later for a lump sum is a separate transaction with its own questions. See our pages on the structured settlement calculator and selling a structured settlement.

Are punitive damages taxable?

Yes, generally, even in a physical-injury case. The exclusion in § 104(a)(2) carves out punitive damages in its own words ("other than punitive damages"). IRS Publication 4345 says punitive damages are taxable and reported as other income even if received in a settlement for personal physical injuries.

A common mistake is calling § 104(c) the rule that makes punitive damages taxable. It is the opposite. Section 104(c) is the one exception, and it lets punitive damages be excluded only in a wrongful-death action where the state's law as of September 13, 1995 (by statute, or by a court decision issued by that date) provided that only punitive damages may be awarded in such an action, and the exception stops applying to actions filed once that state's law no longer provides only punitive damages.

That exception is rare and depends on state law. The calculator flags it rather than computing it. For how punitive damages work in each state, see punitive damages laws by state.

Is interest on a settlement taxable?

Generally yes. Interest on any settlement is generally taxable as interest income, according to IRS Publication 4345. That is true even when the underlying damages are for a physical injury.

Are employment and wrongful termination settlements taxable?

Generally yes. Employment cases are usually not about a physical injury, so the main exclusion does not reach them. The Supreme Court held in Commissioner v. Schleier that a recovery under the Age Discrimination in Employment Act is not excludable.

Back pay, front pay and severance are wages

IRS Publication 4345 says the part of an employment settlement for lost wages, meaning severance pay, back pay and front pay, is taxable wages. It is subject to Social Security and Medicare tax and to withholding by the payer, and it is reported as wages. The IRS treats Title VII back pay the same way: Rev. Rul. 96-65 holds it is wages for FICA, FUTA and income tax withholding.

Many articles skip the payroll tax. For 2026, the employee share of Social Security tax is 6.2% on wages up to $184,500, and Medicare tax is 1.45% with no wage base limit. An employer must also withhold a 0.9% Additional Medicare Tax on wages over $200,000 in a calendar year. The tax itself applies above $200,000 for single filers and $250,000 for joint filers.

Other wages you earn in the same year also affect how much of the payroll tax applies, which the calculator does not model.

Emotional distress in a job case

Emotional distress damages in an employment case are generally taxable income, unless the distress comes from a physical injury that is part of the claim, such as an assault at work. The 1996 conference report says the exclusion does not apply to damages based on a claim of employment discrimination or injury to reputation accompanied by emotional distress, other than medical expenses. The IRS notes that non-physical damages such as emotional distress are generally includable in gross income but not subject to federal employment taxes when they are not wages.

For estimates on a job claim, the employment discrimination settlement calculator looks at what a case may be worth. The settlement tax calculator then shows how each part is taxed.

Are emotional distress damages taxable?

It depends on where the distress came from. If it is attributable to a physical injury or physical sickness, it is treated like the injury and is generally not taxable. If it is not, it is taxable, except for amounts that pay for medical care for the emotional distress.

Physical symptoms do not change the answer. Congress said the term emotional distress includes symptoms such as insomnia, headaches and stomach disorders that result from the distress. IRS Publication 525 says the same, giving unlawful discrimination and injury to reputation as examples of non-physical injuries.

Defamation, consumer and other non-physical claims

Damages for harm that is not physical are generally taxable income. Defamation and other injury-to-reputation claims are the classic example, and in 2026 the Tax Court treated the full settlement of credit-reporting claims as income. The usual exception is money that pays for medical care for emotional distress.

If part of the recovery replaces lost profits from your trade or business, IRS Publication 4345 says that part is net earnings subject to self-employment tax, on top of income tax. Class action payouts follow the same "what was it for" rule. Our page on whether class action settlements are taxable covers data-breach and similar payments.

Property damage settlements

A property-damage recovery, such as payment for a damaged car or house, is generally not income up to your adjusted basis in the property. IRS Publication 4345 says you instead reduce your basis in the property by the amount of the settlement. If the settlement exceeds your adjusted basis, the excess is income. Legal fees and other costs of getting the recovery are subtracted from the amount you receive before any gain is figured, and the calculator nets them out. It never assumes a basis of zero if you leave the basis blank.

Workers' compensation

Benefits paid under a workers' compensation act for an occupational injury or sickness are fully exempt from tax, according to IRS Publication 525, and the exemption also applies to survivors. The exemption does not cover retirement plan benefits based on age, length of service or prior contributions. Pay for light-duty work is taxable as wages. If part of your workers' compensation reduces your Social Security disability benefits, Publication 525 says that part is treated as Social Security benefits and may be taxable.

Attorney fees: why you can be taxed on money your lawyer kept

This is the part most people do not expect. In Commissioner v. Banks, the Supreme Court held that as a general rule, when a litigant's recovery is income, the litigant's income includes the portion paid to the attorney as a contingent fee. The Tax Court applied that rule again in 2026, holding the taxpayers could not escape Banks whether the fee was contingent or paid under a fee-shifting statute.

In a physical-injury case this mostly does not matter, because fees on the excluded part cause no tax. It matters when the recovery is taxable, because you can owe tax on more money than you received.

Who can deduct the fees

Fees and court costs in a claim of unlawful discrimination get an above-the-line deduction under 26 U.S.C. § 62(a)(20), capped at the settlement income you include that year. The definition is broad. It covers laws that enforce civil rights or regulate the employment relationship, including claims for wages, discharge and retaliation. The § 62(a)(20) deduction also covers federal False Claims Act claims, and § 62(a)(21) gives a similar deduction for certain whistleblower awards. Separately, fees paid to recover lost profits of your own trade or business are generally deductible as a business expense.

A sexual harassment or abuse settlement covered by a nondisclosure agreement does not change this for the person receiving it. The IRS says recipients are not precluded from deducting attorney's fees by § 162(q), if the fees are otherwise deductible.

Who cannot

For most other personal taxable claims, such as defamation or a privacy claim, there is no federal deduction for the fees. Miscellaneous itemized deductions are disallowed for every tax year beginning after December 31, 2017. Many articles still say this disallowance ends after 2025. It does not: the 2025 budget law, Pub. L. 119-21, struck the end date, so the rule is now permanent.

The line between the two groups can be narrow. In July 2026, the Tax Court held in Eiler v. Commissioner that claims under the Fair Credit Reporting Act did not involve claims of unlawful discrimination because they did not involve laws enforcing civil rights. The full settlement amounts were included in the taxpayers' income.

Worked examples

These figures come from the calculator's engine, using a 40% contingent fee and federal income tax only.

In the first case, the person pays tax on $40,000 they never received. In the third, only the punitive damages are taxable, and the fee share on that part stays in income because an ordinary injury claim gets no fee deduction. A physical-injury claim brought under a civil-rights law such as 42 U.S.C. § 1983 can be an exception.

Forms 1099 and W-2

For payments made after December 31, 2025, Pub. L. 119-21 raised the general Form 1099 reporting threshold from $600 to $2,000. A payer generally files Form 1099-MISC for taxable other income of at least $2,000. Gross proceeds paid to an attorney are still reported in box 10 at the old $600 level.

When taxable damages are paid through your lawyer, the IRS instructions describe furnishing a Form 1099-MISC to the claimant for the damages and another to the claimant's attorney for the gross proceeds. Lost wages go on a Form W-2 instead.

A form, or no form, does not decide the tax. A taxable payment under $2,000 is still taxable, and a 1099 does not make an excluded injury payment taxable. What controls is what the money was for.

Why the settlement agreement's wording matters

IRS Publication 4345 says the IRS generally will not disturb an allocation if it is consistent with the substance of the settled claims. If the agreement is silent, the IRS says it will look to the intent of the payor to characterize the payments.

That makes the allocation worth discussing before you sign. A clear split between physical injury, emotional distress, wages, punitive damages, interest and fees helps support how you report each part. An allocation that does not match what the case was really about may not hold up. A tax professional can review the draft language with your lawyer.

State income tax

Everything above is federal. States set their own rules, and some differ from the federal treatment, or add limits, in ways that matter for a settlement:

• Pennsylvania does not count damages as taxable compensation where pain and suffering, emotional distress or a similar noneconomic element was, or would have been, a significant evidentiary factor in determining the amount, a test that is not limited to physical injuries. Interest is a separate class of income in Pennsylvania, so interest on an award can still be taxable.
• Massachusetts generally follows the federal approach: it excludes compensatory damages for physical injury or sickness, taxes interest, lost wages or profits outside an injury case, and punitive damages, and does not allow attorney fees to be deducted except in certain discrimination and whistleblower cases.
• California did not follow the federal disallowance of miscellaneous itemized deductions, so certain legal fees may still be deductible on a California return.
• New York itemized deductions include expenses paid to produce or collect taxable income.

Check your own state's tax agency or a tax professional before relying on a state figure.

Before you file

Start with the settlement agreement and any closing statement from your lawyer. They show the gross amount, the fee, costs, and how the money was allocated. Then match each part to the rules above, or enter them in the settlement tax calculator for a federal estimate.

If you are still weighing an offer, our guide to personal injury settlement amounts and the personal injury settlement calculator cover what injuries tend to be worth. This page is general information, not tax advice. A tax professional can tell you how your own settlement should be reported.

Frequently Asked Questions

Are settlements taxable?

It depends on what the settlement pays for. Federal law taxes all income unless a rule excludes it. Damages other than punitive damages for a personal physical injury or physical sickness are generally not taxable. Settlements for job claims, defamation, emotional distress without a physical injury, lost business profits, punitive damages and interest are generally taxable.

Are personal injury settlements taxable?

Compensatory damages for a personal physical injury or physical sickness are generally not taxable under federal law, including the parts for pain and suffering, medical bills, lost wages and emotional distress that comes from the injury. Punitive damages and interest are taxable, and medical costs you deducted on an earlier return come back into income to the extent the deduction lowered your tax.

Are lawsuit settlements taxable?

Many are. Only damages on account of a physical injury or physical sickness fit the main federal exclusion. Settlements of employment, defamation, credit-reporting and business claims are generally taxable, and the contingent fee your lawyer keeps is usually counted as your income too.

Do you pay taxes on a settlement if your lawyer takes a third?

If the settlement is taxable, generally yes, on the full amount. Under Commissioner v. Banks, a contingent fee paid from a taxable recovery is part of your income. Discrimination, civil-rights, employment and certain whistleblower claims can deduct those fees above the line. Fees to recover profits of your own business are a business expense. Most other personal taxable claims cannot deduct the fees, because miscellaneous itemized deductions are permanently disallowed for federal tax.

Is the lost wages part of an injury settlement taxable?

In a case that has its origin in a physical injury or physical sickness, the IRS treats lost wages as part of the excludable injury damages, so they are generally not taxable. In an employment case, lost wages such as back pay, front pay and severance are taxable wages subject to Social Security and Medicare tax.

Are punitive damages taxable?

Yes, even in a physical-injury case. The only exception, in 26 U.S.C. 104(c), covers a wrongful-death action in a state whose law as of September 13, 1995 allowed only punitive damages in wrongful-death cases.

Are emotional distress damages taxable?

They are taxable unless the distress is attributable to a physical injury or physical sickness. Amounts that pay for medical care to treat the distress are excluded. Physical symptoms such as headaches, insomnia or stomach problems caused by the distress do not turn it into a physical injury.

Is a wrongful death settlement taxable?

Compensatory damages in a wrongful-death case remain excludable under federal law. Punitive damages are generally taxable, except in the narrow case of a state whose law as of September 13, 1995 allowed only punitive damages in wrongful-death actions. Interest on the award is generally taxable.

Is a wrongful termination or discrimination settlement taxable?

Generally yes. Back pay, front pay and severance are wages, so income tax and your share of Social Security and Medicare tax are withheld and the payment goes on a W-2. Emotional distress damages are generally taxable other income, unless they come from a physical injury that is part of the claim. Attorney fees in these cases can qualify for an above-the-line deduction capped at the settlement income you report.

Are workers compensation benefits taxable?

Benefits paid under a workers compensation act for an occupational injury or sickness are fully exempt from federal income tax, and the exemption also applies to survivors. If part of the benefits reduces your Social Security disability benefits, that part is treated as Social Security benefits and may be taxable. It does not cover retirement plan benefits based on age or length of service, and pay for light-duty work is taxable as wages.

Will I get a 1099 for my settlement?

For payments made after 2025, a payer generally issues Form 1099-MISC for taxable other income of $2,000 or more, and wages go on a W-2. Gross proceeds paid to your attorney are reported in box 10 at $600 or more. A taxable payment is taxable whether or not you receive a form.

Is a structured settlement taxed differently?

The federal exclusion for physical injury damages applies whether the money is paid as a lump sum or as periodic payments. Selling structured payments later for a lump sum is a separate transaction with its own questions.

Does my state tax a settlement?

States set their own rules. Pennsylvania does not count damages as taxable compensation where noneconomic harm was a significant evidentiary factor, Massachusetts generally follows the federal approach and allows fee deductions only in certain discrimination and whistleblower cases, California did not follow the federal ban on miscellaneous itemized deductions, and New York allows itemized expenses to produce or collect taxable income. Check your state tax agency or a tax professional.