Are Personal Injury Settlements Taxable in Illinois?

If you’ve recently received a personal injury settlement — or you’re pursuing one — you may be wondering whether the money is subject to taxes. After all, a settlement can represent compensation for a serious accident, lost wages, medical bills, and even pain and suffering. So, do you owe the IRS or the State of Illinois a portion of that money?

The short answer is: many types of personal injury settlements are not taxable, but some portions might be, depending on how the settlement is structured. The rules can get tricky, especially when different types of damages are involved. In this blog, we’ll break down what parts of a personal injury settlement are taxable, what’s not, and how to protect yourself when tax season rolls around.

Federal vs. State Tax: Who’s Taxing You?

First, let’s distinguish between federal and state taxes. The IRS governs federal tax laws, while the Illinois Department of Revenue oversees state income taxes. In general, Illinois follows federal guidelines when it comes to the taxation of personal injury settlements. That means if the IRS doesn’t tax a particular portion of your settlement, Illinois likely won’t either.

Still, it’s crucial to understand what those federal guidelines say — because the IRS doesn’t treat all settlement money the same.

What Types of Personal Injury Settlement Money Are Not Taxable?

1. Compensation for Physical Injuries or Physical Sickness

If you receive a settlement for a physical injury — for example, a broken bone, whiplash, or a concussion — that money is generally not taxable. This includes compensation for:

Medical bills
Pain and suffering
Emotional distress (if directly tied to the physical injury)
Loss of enjoyment of life (again, if tied to physical harm)

Even if the settlement is substantial, as long as it’s linked to a physical injury or illness, you typically won’t pay taxes on it at either the state or federal level.

Example: You’re in a car accident and suffer a herniated disc. You settle your case for $100,000, which includes reimbursement for your medical bills and pain and suffering. The entire amount is likely non-taxable.

2. Reimbursement for Out-of-Pocket Medical Expenses

Whether you paid your medical bills directly or your health insurance covered them and you later reimbursed your insurer, the portion of your settlement that goes toward medical costs is not taxable — as long as you didn’t previously deduct those expenses on a prior year’s tax return.

If you did deduct the expenses to reduce your taxes in a previous year, then the IRS may consider part of your settlement taxable to avoid a double benefit.

Tip: Keep copies of your tax returns, medical bills, and any insurance reimbursements to help track what you can and can’t exclude.

What Parts May Be Taxable?

While many personal injury settlement amounts are non-taxable, there are some important exceptions. Here are the most common taxable elements of a settlement:

1. Lost Wages

If part of your settlement compensates you for income you lost while recovering from your injuries, that portion is considered taxable — just like regular income.

The IRS and the state of Illinois both treat lost wages the same way they’d treat the wages you would have earned at your job. That means this portion could be subject to income tax and FICA (Social Security and Medicare) taxes.

Example: If $20,000 of your $100,000 settlement is for lost wages, you’ll need to report that $20,000 on your tax return.

2. Interest on the Settlement

Sometimes, personal injury settlements include interest, particularly if the case dragged on for years or you received a judgment in court. The IRS considers interest income to be taxable, and Illinois does, too.

So, if your settlement or court award includes interest from the time the injury occurred until the time you got paid, that interest is likely taxable.

3. Punitive Damages

Punitive damages are meant to punish the wrongdoer, not to compensate you for your injuries. Because of this distinction, punitive damages are fully taxable under federal and Illinois law.

Even if your case arose from a physical injury, punitive damages stand apart from your compensatory damages and are treated differently by the IRS.

Example: If a jury awards you $200,000 — $150,000 in compensatory damages and $50,000 in punitive damages — you would likely only owe taxes on the $50,000.

4. Emotional Distress Without Physical Injury

If you received money solely for emotional distress, such as anxiety or depression, but you didn’t also suffer a physical injury, then the IRS generally considers that taxable income.

However, if the emotional distress was a direct result of a physical injury, the amount may be excluded from your taxable income.

The distinction can be subtle, but it’s important. A medical diagnosis related to trauma from the injury can help establish that the distress is tied to a physical condition.

What About Structured Settlements?

Structured settlements are agreements where the settlement is paid out in installments over time, rather than in a single lump sum. The tax treatment of structured settlements mirrors that of lump-sum settlements:

Payments for physical injuries are still non-taxable.
Payments for lost wages or punitive damages are still taxable.

However, if the payments include interest, that interest portion may be taxable each year as it’s received.

Note: The way your structured settlement is set up — and how it’s categorized in the settlement agreement — can make a big difference in how it’s taxed.

The Importance of How the Settlement Is Written

One of the most important things you can do to protect yourself from unnecessary tax liability is to clearly spell out the breakdown of your settlement in your agreement.

Many settlements are negotiated as a single lump sum. However, if the agreement doesn’t specify how much of that amount is for lost wages, medical bills, pain and suffering, etc., the IRS may make its own assumptions — and you may end up paying taxes you could have avoided.

Your attorney can work with the insurance company or opposing counsel to ensure the settlement is properly allocated in writing. This can be the difference between paying taxes and keeping more of your money.

Will You Get a 1099?

Whether or not you’ll receive a Form 1099-MISC (which reports miscellaneous income to the IRS) depends on the nature of the settlement:

If your settlement is entirely non-taxable (e.g., only for physical injuries), you may not receive a 1099.
If any portion of your settlement is taxable — like punitive damages, emotional distress not tied to a physical injury, or lost wages — you may receive a 1099 for that amount.

Be sure to review any tax documents you receive and cross-reference them with your settlement agreement. If something doesn’t look right, talk to your lawyer or a tax professional.

Don’t Go It Alone: When to Talk to a Tax Professional

Taxes on personal injury settlements can get complicated fast, especially when there are multiple types of damages involved. Here are a few scenarios where you should definitely consult a tax advisor:

You deducted medical expenses in previous years related to the injury.
Your settlement includes punitive damages or interest.
You have a structured settlement.
You’re unsure how the settlement was categorized or you didn’t get a detailed breakdown.

Your personal injury attorney may also work with tax professionals or be able to refer you to someone who understands the intersection of personal injury law and tax law.

Keep More of What You Deserve

A personal injury settlement is meant to make you whole again — not to enrich the government. Fortunately, most personal injury settlements in Illinois are not taxable, especially if they’re compensating you for physical injuries or medical expenses.

But don’t assume the whole settlement is tax-free. The moment your award includes things like lost wages, interest, or punitive damages, the IRS and the Illinois Department of Revenue may come calling.

The key is to know how your settlement is categorized and to structure it carefully from the start. Working with an experienced personal injury attorney and consulting a tax professional when needed can help you avoid tax pitfalls and keep more of what you’re owed.

Contact the Award-Winning Illinois Personal Injury Lawyers at John J. Malm & Associates

Need help with a personal injury claim in Illinois? At John J. Malm & Associates, our top-rated accident attorneys are here to guide you through the process — from negotiating the best possible settlement to helping you understand what you’ll owe (and what you won’t) come tax time. Contact us today for a free consultation and let us help you get the compensation you deserve.