Taxation of Legal Settlements or Awards

Article Highlights:

  • Physical Injury and Physical Sickness 
  • Wrongful Death 
  • Emotional Distress 
  • Previously Deducted Medical Expenses 
  • Employment Discrimination 
  • Age Discrimination 
  • Unpaid or Disputed Employment Earnings 
  • Interest 
  • Settlements 
  • Legal Costs 
The tax treatment of awards received as the result of a lawsuit could result in taxable or non-taxable income, depending upon a number of issues. The laws are often complex and sometimes seemingly discriminatory. The actual taxation of an award is primarily based on the following factors:
  • The nature of the legal action, 
  • The type of award, and 
  • Whether a settlement occurred before trial 
Generally, all monetary awards as the result of a legal action are fully taxable, with one exception. Under the exception, the tax code allows an exclusion from gross income for damages received due to a personal physical injury or physical sickness. Consequently, when a lawsuit is based on a physical injury or sickness, all damages (other than punitive damages, which are generally always taxable) flowing from that suit are treated as payments received due to a physical injury or sickness and are therefore excludable from income. This is true whether or not the recipient of the damages is the injured party.

Here are some commonly encountered situations and their taxability:
  • Age Discrimination – Tax law doesn’t consider back pay or liquidated damages received under the Age Discrimination in Employment Act (ADEA) to be compensation for personal injuries; therefore, these payments are fully taxable. 

  • Emotional Distress – Emotional distress isn’t considered a physical injury or physical sickness and is therefore taxable. However, if an amount of an award or a settlement is paid for medical care related to emotional distress, that amount may be excludable; see Medical Expenses below. 

  • Employment Discrimination – No exclusion is allowed for damages received in a suit involving employment discrimination or an injury to reputation that is accompanied by a claim of emotional distress. 

  • Interest – Interest that may be included in an award, even one for personal injury or sickness, is not excludable and must be included in gross income. 

  • Previously Deducted Medical Expenses – Generally, when a settlement or award includes reimbursement for medical expenses – such as awards for physical injury, physical sickness and even emotional distress – that portion of the award is excludable. However, any portion of those expenses that was previously allowed as a medical deduction would be taxable. 

  • Punitive Damages – Punitive damages are made as a punishment for unlawful conduct and are always taxable; they cannot be excluded from income like damages received due to personal physical injury or physical sickness, except as noted below for wrongful death. 

  • Wrongful Death – Wrongful death is considered physical injury or physical sickness for purposes of the income exclusion. In addition, punitive damages are excludable where state law provides that only punitive damages can be awarded in wrongful death suits. 

  • Unpaid or Disputed Employment Earnings – Back pay, severance pay, overtime pay, etc., are all treated as W-2 type income and are both taxable and subject to payroll FICA withholding. 
It is not uncommon in legal actions for the plaintiff to sue for both excludable and non-excludable damages. For example, an employee is injured on the job and sues for back vacation pay of $10,000 and damages for personal injury of $90,000 (a total of $100,000). If the suit is settled for $50,000 without a stipulation of how the settlement will be applied, the settlement will need to be allocated in the same manner as the original suit. In this example, $5,000 of the settlement would be allocated for back vacation pay (taxable), and $45,000 would be for personal injury (excludable).

Prior to the passage of the Tax Cuts and Jobs Act (TCJA), legal costs associated with personal or employment-related legal actions could only be deducted as a miscellaneous itemized deduction on the employee’s Schedule A itemized deductions, reduced by 2% of the taxpayer’s adjusted gross income (AGI). However, the TCJA suspended the deduction for itemized deductions subject to the 2% of AGI floor for years 2018 through 2024. As a result, for those years, a taxpayer will have to include the full amount of the taxable settlement or award in income and will be unable to deduct the amount paid to the attorney.

So, don’t spend any of that settlement or award money before determining what the government’s cut is. Please call this office to see if you owe any taxes, determine if any actions can be taken to reduce the tax or determine if any pre-payments of tax need to be made.

Share this article...

Want tax & accounting tips and insights?

Sign up for our newsletter.

I confirm this is a service inquiry and not an advertising message or solicitation. By clicking “Submit”, I acknowledge and agree to the creation of an account and to the and .
I consent to receive SMS messages

Title: Accounting / Tax Manager 

We are seeking an Accounting/Tax Manager to join our team! You will lead and manage multiple operations of the tax practice area and deliver quality tax services that will increase the firm’s reputation. You will oversee the work of accountants, review financial statements, and prepare reports. Schedule: Monday to Friday. 

Job Type: Full-time. 

Interested parties please call 214-646-0300.  

Duties and Responsibilities: 

  • Manage and Prepare tax returns for over 2,000 individuals, businesses, non-profits and estates 

  • Contact clients to obtain tax documents 

  • Review tax returns with clients 

  • Provide basic tax planning/solutions services to clients 

  • Accounting/Bookkeeping for firm clients in various accounting software (QBO, QBD, Intacct, Xero, Wave, Zoho Books, BQE Core, etc...) 

  • Other administrative tasks when necessary: 

  • Plan and schedule appointments and events 

  • Greet and assist onsite guests 

  • Answer inbound telephone calls 

  • Draft correspondences and other formal documents 

  • Develop and implement organized filing systems 

  • Manage requests from website and social media management company 


  • Tax preparation experience is required 

  • Experience with Lacerte / Drake Tax software is required 

  • QuickBooks experience is required 

  • Previous experience in office administration or other related fields 

  • Ability to prioritize and multitask 

  • Excellent written and verbal communication skills 

  • Strong attention to detail 

  • Strong organizational skills 

  • Must be able to speak Hindi and English 

Education: Bachelor's (Required), CPA (required), Enrolled Agent: Preferred. 

Experience level: 3 years. 


Salary: $75,000.00 - $110,000.00 per year 


  • 401(k) 

  • 401(k) matching 

  • Dental insurance 

  • Disability insurance 

  • Health insurance 

  • Life insurance 

  • Paid time off 

  • Vision insurance 

  • Work from home 


Interested parties please call 214-646-0300.