During tax season, many clients ask me if they owe taxes on their personal injury settlement or award. My usual answer is that, generally speaking, compensation for physical injuries is non-taxable and the money does not need to be reported on your income tax return. There are a few exceptions such as punitive damage awards and interest income received from an award or settlement. If you are in doubt, contact your tax professional.
If you receive a settlement for physical injuries or sickness and did not take an itemized deduction for medical expenses related to this injury in prior years, the full amount is non-taxable, but if you took a deduction for medical expenses related to the injury or sickness, the tax benefit amount is taxable and should be reported as “Other Income” on line 21 of Form 1040.
For a full review of the rules, follow the link to the IRS website, and see Publication 525, Taxable and Nontaxable Income, http://www.irs.gov