If you’ve received a personal injury settlement in South Carolina—or are currently pursuing one—it’s important to understand the potential tax consequences. Many people ask whether they’ll owe state or federal taxes on the money they receive. The answer depends on what your settlement is compensating you for.
The good news is that most personal injury settlements in South Carolina aren’t taxable. However, there are some important exceptions you should be aware of. Certain categories of damages, such as punitive damages or emotional distress unrelated to a physical injury, may be subject to taxation under federal law.
Understanding how these distinctions work can help you protect your compensation and avoid surprises during tax season. Contact a South Carolina personal injury lawyer to learn more.
When Personal Injury Settlements Are Tax-Free
The general rule under Internal Revenue Code § 104(a)(2) is that compensation for personal physical injuries or physical sickness is excluded from your gross income. South Carolina law aligns with this federal standard.
That means if your case involves a physical injury—such as one caused by a car accident, slip and fall, or other negligence—you typically won’t owe taxes on the amount you receive for:
- Medical expenses
- Pain and suffering
- Physical limitations or disability
- Lost wages related to time missed from work due to your injuries
- Loss of enjoyment of life or similar non-economic damages tied to physical harm
This rule applies regardless of whether your settlement was negotiated privately or awarded by a court judgment. The determining factor is the nature of the claim—not how the case was resolved.
For example, if you were rear-ended by a distracted driver, broke your leg, missed three months of work, and settled your case for compensation covering those losses, that money is generally not taxable at either the federal or state level.
Which Parts of a Settlement May Be Taxable?
While most of your compensation for physical injuries is exempt from taxes, not all types of damages are treated the same. The IRS and South Carolina Department of Revenue both require that certain types of settlement funds be reported as taxable income.
Punitive Damages
Punitive damages are taxable under federal law. These damages are awarded not to compensate the victim, but to punish the defendant for egregious, reckless, or malicious conduct.
For example, in a DUI accident case, a jury might award punitive damages if the defendant’s actions were especially dangerous. If you receive a punitive damages award, that portion of the settlement must be reported on your federal tax return and may be subject to South Carolina state income tax as well.
Even if the rest of your compensation is tax-free, the IRS requires you to separately allocate punitive damages and treat them as income.
Emotional Distress or Mental Anguish Without Physical Injury
If your settlement includes damages for emotional distress, anxiety, or mental anguish as a part of your South Carolina personal injury settlement, they may be taxable unless they are directly connected to a physical injury or illness.
For instance:
- If you were in a car accident, broke your collarbone, and also developed PTSD related to the crash, the emotional distress portion is likely non-taxable because it stems from a physical injury.
- But if you filed a claim for workplace harassment without a physical injury, any compensation for emotional distress would be taxable.
The IRS draws a clear line between emotional suffering caused by physical injuries and emotional harm without any physical component. South Carolina follows this same principle.
Interest on the Settlement
If your settlement includes pre–judgment or post–judgment interest—for example, interest that accrues while your case is pending or after a court award—that interest is taxable income. This applies even if the rest of your settlement is non-taxable.
Both federal and South Carolina tax authorities require you to report settlement interest as you would report interest earned from a savings account or investment.
How Lost Wages Are Treated
One area where tax rules can get confusing is lost wages. Generally, if the lost wages are due to time missed from work because of a physical injury, that portion is considered part of the physical injury compensation—and is therefore not taxable.
However, if your claim involves non-injury-related lost wages, such as in an employment discrimination or breach of contract case, the lost wage portion of your award would be taxed just like regular income. It may even be subject to payroll taxes, depending on how the payment is processed.
In personal injury claims involving bodily harm, the IRS typically views lost income as an extension of the physical injury—and as such, does not tax it.
The Tax Benefit Rule: Medical Deductions and Reimbursements
There’s another key exception you should be aware of: the tax benefit rule.
If you previously deducted medical expenses on your federal income tax return—for example, if your out-of-pocket injury-related costs exceeded 7.5% of your adjusted gross income—and you later receive a settlement that reimburses those same expenses, the IRS may require you to repay that deduction.
The idea is simple: you can’t receive a tax break for the same medical expense twice—once as a deduction and again as part of a tax-free settlement. If this situation applies to you, it’s a good idea to speak with a tax advisor about how to properly report the reimbursement.
Structuring the Settlement: Why Language Matters
It’s not just the type of damages you receive that determines whether they are taxable—it’s also how the settlement agreement is written.
When your case resolves, the written agreement should specify exactly which portions of the settlement are for medical expenses, lost wages, pain and suffering, punitive damages, or other categories. The IRS and South Carolina Department of Revenue often refer to this allocation when determining taxability.
For example:
- If your settlement clearly states that $75,000 of the total award is for physical injuries and $25,000 is for punitive damages, only the $25,000 is taxable.
- If no allocation is made and the settlement is ambiguous, the IRS may decide to treat a larger portion as taxable, particularly if they believe the case involved emotional distress or non-injury damages.
This is one reason why working with an experienced attorney—and consulting a tax professional when needed—is crucial. Clear documentation now can prevent disputes or audits later.
South Carolina Tax Treatment of Personal Injury Settlements
South Carolina does not have any special tax law that overrides federal IRS rules in this area. The South Carolina Department of Revenue generally follows the same approach as the IRS when determining what is and isn’t taxable in a personal injury settlement.
This means that:
- Physical injury damages are not taxable at the state level.
- Punitive damages and settlement interest are taxable.
- Emotional distress damages are taxable unless they stem directly from a physical injury.
If you owe federal income tax on a portion of your settlement, you should expect to owe South Carolina state income tax on that portion as well.
Planning Ahead: What You Can Do
If you’re in the process of settling a personal injury claim or have recently received funds, take the time to understand what portions of your compensation are taxable and prepare accordingly.
Here’s what you can do:
- Review your settlement agreement carefully.
- Ask your attorney to explain how each type of damage is categorized.
- If needed, work with a tax advisor to review prior deductions or report income accurately.
- Keep all documentation, including 1099 forms, medical bills, and IRS correspondence, in case of future questions.
Being proactive about the tax side of your settlement can help you avoid penalties and preserve the full value of your recovery.
Have Questions About the Taxability of Your Settlement?
Most personal injury settlements in South Carolina are not taxable, but not all compensation is treated equally. Understanding what is and isn’t taxable, and structuring your agreement accordingly, is critical to protecting your financial recovery.
If you’re unsure how your settlement will be taxed or want to avoid costly mistakes, we’re here to help.
At Auger & Auger, we’ve spent over 30 years helping injury victims across South Carolina not only secure fair compensation but also understand how their recovery fits into the bigger financial picture. From negotiating with insurers to drafting strong settlement agreements, our goal is to protect every aspect of your case—including its future impact.
With our A&A Zero Fee Guarantee, you pay nothing unless we win your case. We’ll walk you through your options and ensure your settlement is handled with clarity, care, and the legal protection you deserve.
