See this IRS analysis regarding the taxability of settlements and judgments.
Awards and settlements can be divided into two distinct groups to determine whether the payments are taxable or non-taxable. The first group includes claims relating to physical injuries, and the second group is for claims relating to non-physical injuries. Within these two groups, the claims usually fall into three categories:
- Actual damages resulting from physical or non-physical injury;
- Emotional distress damages arising from the actual physical or non-physical injury; and
- Punitive damages
The Service has consistently held that compensatory damages, including lost wages, received on account of a personal physical injury are excludable from gross income with the exception of punitive damages.
Contact the payer if you didn't receive a breakdown of the nature of the payment received, to determine the amount of the payment that represented taxable punitive damages rather than compensatory damages, such as for medical expenses.
Compensatory damages paid on account of personal physical injuries or physical sickness are not taxable, as pointed out by Opus 17 below.
[Edited 02/27/23|6:51 PM PST]
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