Settlements—Taxability

If you receive proceeds from settlement of a lawsuit, you may have questions about whether 
you must include the proceeds in your income. This publication provides information about 
whether you must include the proceeds of certain kinds of settlements in your income. 
Whether you must include the settlement proceeds in your income depends on all the facts 
and circumstances in your case. 

A settlement payment may consist of multiple elements that have been allocated by the 
parties. For example, an agreement may include allocations to back pay, emotional distress, 
and attorneys’ fees. Generally, the IRS will not disturb an allocation if it is consistent with the 
substance of the settled claims. 

Personal physical injuries or physical sickness 

    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. 

                                       –BUT– 

    If you receive a settlement for personal physical injuries or physical sickness, you must include in 
 
  ‧ income that portion of the settlement that is for medical expenses you deducted in any prior year(s) 
    to the extent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses 
    you paid in more than one year, you must allocate on a pro rata basis the part of the proceeds for 
    medical expenses to each of the years you paid medical expenses. See Recoveries in Publication 
    525 for details on how to calculate the amount to report. The tax benefit amount should be reported 
    as “Other Income” on line 8z of Form 1040, Schedule 1. 

Emotional distress or mental anguish 

    The proceeds you receive for emotional distress or mental anguish attributable to a personal physical 
 
  ‧ injury or physical sickness are treated the same as proceeds received for Personal physical injuries or 
    physical sickness above. 

                                       –BUT– 

    If the proceeds you receive for emotional distress or mental anguish do not originate from a personal 
 
  ‧ physical injury or physical sickness, you must include them in your income. However, the amount you 
    must include is reduced by: (1) amounts paid for medical expenses attributable to emotional distress 
    or mental anguish not previously deducted and (2) previously deducted medical expenses for such 
    distress and anguish that did not provide a tax benefit. Attach to your return a statement showing 
    the entire settlement amount less related medical costs not previously deducted and medical costs 
    deducted for which there was no tax benefit. The net taxable amount should be reported as “Other 
    Income” on line 8z of Form 1040, Schedule 1. 

Lost wages or lost profits 

    If you receive a settlement in an employment-related lawsuit; for example, for unlawful discrimination 
 
  ‧ or involuntary termination, the portion of the proceeds that is for lost wages (i.e., severance pay, back 
    pay, front pay) is taxable wages and subject to the social security wage base and social security 
    and Medicare tax rates in effect in the year paid. These proceeds are subject to employment tax 
    withholding by the payer and should be reported by you as wages on Line 1a of Form 1040. 

    If you receive a settlement for lost profits from your trade or business, the portion of the proceeds 
 
  ‧ attributable to the carrying on of your trade or business is net earnings subject to self-employment 
    tax. These proceeds are taxable and should be included in your “Business income” reported on line 
    3 of Form 1040, Schedule 1. These proceeds are also included on line 2 of Schedule SE (Form 1040) 
    when figuring self-employment tax. For more information about reporting self-employment income 
    and paying self-employment tax, see Publication 334, Tax Guide for Small Business (For Individuals 
    Who Use Schedule C or C-EZ). 

Loss-in-value of property 

    Property settlements for loss in value of property that are less than the adjusted basis of your 
 
  ‧ property are not taxable and generally do not need to be reported on your tax return. However, you 
    must reduce your basis in the property by the amount of the settlement. 

    If the property settlement exceeds your adjusted basis in the property, the excess is income. For 
 
  ‧ more information, see the Instructions for Schedule D, (Form 1040) Capital Gains and Losses and the 
    Instructions for Form 4797, Sales of Business Property. 

Interest: Interest on any settlement is generally taxable as “Interest Income” and should be reported on 
line 2b of Form 1040. 

Punitive Damages: Punitive damages are taxable and should be reported as “Other Income” on line 
8z of Form 1040, Schedule 1, even if the punitive damages were received in a settlement for personal 
physical injuries or physical sickness. 

Estimated Payments: Some settlement recipients may need to make estimated tax payments if they 
expect their tax to be $1,000 or more after subtracting credits & withholding. Information on estimated 
taxes can be found in IRS Publication 505, Tax Withholding and Estimated Tax, and in Form 1040-ES, 
Estimated Tax for Individuals. 

For additional information, see Publication 525, Taxable and Nontaxable Income, visit our website at 
www.irs.gov, or call toll-free at 1-800-829-1040. 

Important Note about Health Insurance Coverage. If you, your spouse, or your dependent enrolled 
in health insurance coverage through the Health Insurance Marketplace and advance payments of 
the premium tax credit were made to the insurance company, let the Marketplace know if you have a 
change in circumstances such as a taxable settlement resulting in an increase in your income. Reporting 
changes allows the Marketplace to adjust the amount of your advance credit payments, which helps 
prevent large differences between your advance credit payments and the premium tax credit you are 
allowed.  Find out more about the tax-related provisions of the health care law at IRS.gov/aca. See IRS 
Publication 5152, Report changes to the Marketplace as they happen. 

All of the forms and publications referenced in this publication are available from the IRS at 
www.irs.gov. Paper copies can be ordered by calling 1-800-829-3676 (1-800-TAX-FORM). 

Publication 4345 (Rev. 11-2022)  Catalog Number 38586D  Department of the Treasury  Internal Revenue Service   www.irs.gov