When you receive a settlement, one of the first questions is: “Will I owe taxes on this?”
The frustrating (but important) answer is: it depends.
For federal tax purposes, settlement money is generally taxed based on what it’s meant to compensate you for. Some parts of a settlement are often not taxable (most commonly, compensation for physical injury or physical sickness). Other parts may be partly or fully taxable, such as lost wages, emotional distress not tied to a physical injury, punitive damages, and sometimes interest. The wording of the settlement agreement and how different damages are allocated can also matter.
Important disclaimer: Cohen & Winters is a law firm, and we are not tax professionals. The information below is general educational guidance, not tax advice. Tax outcomes can vary significantly depending on the facts of your case and how your settlement is structured and documented. Before making any tax decisions, you should consult a qualified tax advisor (CPA or tax attorney) about your specific settlement.
With that context in mind, here are general guidelines for a few common settlement categories.
Physical Injuries or Physical Sickness: Usually Not Taxable
If your settlement is for physical injuries or physical sickness, the general rule under federal tax law is this: You usually do NOT have to pay income tax on that money.
That includes compensation for:
Medical bills
Pain and suffering related to physical injury
Emotional distress that stems directly from a physical injury
Lost wages tied to the physical injury
For example, if you were injured in a car accident and received a settlement for your injuries, pain, and medical expenses, that money is typically not considered taxable income.
This is one of the most common situations we see, and for many clients, it’s a relief to learn.
Emotional Distress: It Depends
This is where things start to get a little more nuanced.
If emotional distress is caused by a physical injury, it’s generally treated the same way as the physical injury itself — meaning it’s usually not taxable.
But if the emotional distress is not connected to a physical injury, the IRS often considers that portion of the settlement taxable.
Think stress, anxiety, or reputational harm without a physical injury involved.
That doesn’t mean the whole settlement is taxable. It means the classification of the damages matters.
And yes, how the settlement agreement is written can make a real difference.
Lost Wages: Often Taxable
This one surprises people.
If part of your settlement is meant to replace lost wages, that portion is generally taxable — even if the wages were lost because of an injury.
Why? Because wages are normally taxable income.
So if your settlement includes compensation for income you would have earned, the IRS usually wants to treat it the same way it would have treated your paycheck.
That portion may be subject to:
Federal income tax
Possibly state tax (depending on the situation)
In some cases, payroll taxes
This is a key reason why proper allocation in a settlement matters.
Punitive Damages: Almost Always Taxable
Punitive damages are designed to punish bad behavior, not compensate you for a loss. Because of that, punitive damages are almost always taxable, regardless of the type of case. Even if they come from a personal injury lawsuit.
If punitive damages are part of your settlement, you should assume that portion will be taxed unless advised otherwise by a qualified tax professional.
What About Attorney’s Fees?
Another common question.
In many cases, the IRS considers the entire settlement amount as income to you — even the portion that goes directly to your attorney. That doesn’t mean you can’t deduct legal fees in some situations, but the rules are complicated and depend heavily on the type of case. This is an area where coordination between your attorney and your tax professional is especially important.
At Cohen & Winters, we flag this early so clients aren’t blindsided later.
Structured Settlements and Tax Planning
Some settlements are paid over time rather than in one lump sum.
Structured settlements can sometimes offer tax advantages, depending on the nature of the damages and how they’re set up. This isn’t right for every case. But when it makes sense, planning early can help protect more of your recovery.
Once the paperwork is signed and the money is paid, your options narrow significantly.
Why the Settlement Language Matters
Here’s something many people don’t realize:
The way a settlement agreement is written can affect how it’s taxed.
How damages are described. How amounts are allocated. What categories the money falls into. These details matter.
At Cohen & Winters, we don’t just focus on resolving the legal dispute. We also think about downstream consequences — including taxes — and work to structure settlements as thoughtfully as possible under the law.
New Hampshire Perspective
While New Hampshire does not have a broad-based earned income tax like some states, federal tax rules still apply.
And depending on the type of settlement, other state-level considerations may come into play.
Assuming “New Hampshire has no income tax, so I’m fine” can be a costly mistake.
The Bottom Line
So, do you have to pay taxes on your settlement?
What matters is:
The type of case
The nature of the damages
How the settlement is structured
And how it’s documented
This is not an area where guesswork pays off.
Our attorneys at Cohen & Winters have extensive experience guiding clients through settlements and helping them understand the real-world implications — not just the legal outcome.
We work to:
Explain tax considerations in plain language
Coordinate with tax professionals when needed
Structure settlements thoughtfully and strategically
Help clients avoid unpleasant surprises after the case is over
A settlement is meant to bring closure, not create new stress. If you’re negotiating a settlement or have questions about one you’ve already received, getting clear guidance now can save you significant frustration later. Contact our team for help and answers to questions you might have about settlements.