Are Lawsuit or Accident Settlements Taxable?

Settlements to compensate you for physical injuries or sickness suffered in an accident are tax-free. So is the amount paid to compensate you for loss of your car, or medical expenses, except to the extent that those expenses were deducted in an earlier year and provided a tax benefit.

Punitive damages awarded in a lawsuit, and any damages award for non-physical injuries, are generally taxable.

Your legal expenses in obtaining a judgment in your favor can be deducted only in the same proportion as the resulting damages are taxable to you. For example, if your attorney won damages for your physical injury that were 80% compensatory (not taxable) and 20% punitive (taxable), only 20% of the fee paid to him can be claimed as a miscellaneous itemized deduction, subject to the 2% of AGI limitation.

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