Neither the federal government (IRS) or the state can tax you on the settlement or verdict proceeds in most personal injury claims. Federal tax law excludes damages received as a result of personal physical injuries or physical sickness from a taxpayer’s gross income. Recent changes in tax law may allow punitive damages and interest to be taxable. The injuries must be physical to qualify for tax-free treatment, as emotional distress is not enough in itself. Insomnia, headaches, and stomachaches have been deemed normal byproducts of emotional distress and could be taxable.

Settlements or awards that provide compensation for physical injuries, emotional distress or lost wages as a result of physical injuries are specifically excluded by the IRS.  However, any interest earned from money received in a settlement or award is not tax exempt.

According to the IRS, “If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income.”

– source: Publication 4345 at IRS.gov

Learn More:  https://thefernandezlawgroup.com/personal-injury/resources-and-information/frequently-asked-questions-about-personal-injury/