Most injury money is tax-free — but not all of it. Split your settlement into its parts and see what the IRS can touch, with the rule for each line shown.
Reviewed August 24, 2026 · methodology · changelogEducational estimate under IRC §104(a)(2), not tax advice — confirm your situation with a CPA or tax professional.
The tax code excludes from income any damages received "on account of personal physical injuries or physical sickness." That one phrase decides everything: money that flows from a physical injury — medical bills, pain and suffering, even lost wages in a personal injury case — is tax-free. Money that doesn't — punitive damages, interest on the award, employment-claim wages, emotional distress without physical injury — is ordinary income.
The IRS reads your settlement agreement. An agreement that allocates $90,000 to bodily injury and $10,000 to interest produces a very different tax bill than a lump sum the IRS characterizes after the fact. Before signing, make sure the agreement's allocation matches the reality of your claim — and confirm the outcome with a tax professional.
Usually not on the core of it. Compensation for physical injuries or physical sickness — including the pain and suffering and medical costs that flow from them — is excluded from income under IRC §104(a)(2). Punitive damages, interest, and most employment-claim wages are taxable.
It depends on the origin. Emotional distress that flows from a physical injury is tax-free with the rest of the injury award. Emotional distress on its own — say, from a discrimination claim with no physical injury — is taxable, minus any medical costs you paid to treat it.
Effectively no. Punitive damages are taxable even when the underlying case is a physical injury. If your settlement doesn't allocate amounts between compensatory and punitive, the IRS can characterize it for you — good settlement agreements spell the allocation out.
In a tax-free physical injury case it doesn't matter. In taxable cases it can hurt: you may owe tax on the gross amount even though your attorney kept a third of it, unless an above-the-line deduction applies (as it does for many employment claims). This is exactly the situation to run past a CPA.