Are Personal Injury Settlements Taxable In Kentucky?

Following a personal injury settlement, or when thinking about pursuing a personal injury claim, a common question our Kentucky personal injury lawyers help address is concerns about potential tax implications from personal injury settlements.

Tax liability becomes very important to understand after recovering settlement money after a personal injury claim, but the good news is that proceeds from your injury settlement are typically not taxable by either the Commonwealth of Kentucky or the federal government, though there are exceptions depending on various factors, including the types of damages you recover, how the settlement is structured by your personal injury attorney, and other considerations under Kentucky law that impact how settlements are handled for minors.

Types of personal injury settlement damages a victim can recover in Kentucky

To fully understand what may be taxable following a personal injury settlement, let’s first review what damages a personal injury victim may be entitled to recover in Kentucky.

In Kentucky, individuals may seek to recover personal injury damages after being injured by a negligent party. Damages refer to the loss or harm that the negligent party caused the victim to suffer and are awarded in the form of monetary compensation. In other words, the settlement money a victim recovers after a successful claim is the mutually agreed-upon financial amount assigned to the damages in order to resolve the dispute. Once the amount is agreed on, a settlement is reached, and the claim is resolved.

A victim who sustained injuries due to another’s negligence in Kentucky can recover damages that are classified under two primary categories, which are economic damages and non-economic damages. These damages are referred to as compensatory damages, meaning that their purpose is to “make the plaintiff whole again“, aiming to restore the victim to the position they were in before the defendant’s actions caused them harm.

Economic Damages

Think of economic damages as things that can be tied back to a bill or receipt. These financial losses are quantifiable and include:

• Lost wages
• Medical expenses (including future medical expenses related to the injury)
• Property damage
• Reduced earning capacity

All of these items have a specific dollar amount associated with them, and direct evidence can be produced by the plaintiff to prove the expense or loss.

Non-Economic Damages

Non-economic damages are intangible, meaning that they are subjective. These are the emotional, psychological, and physical tolls a victim suffers as the result of someone else’s negligence. Non-economic damages can include:

• Pain and suffering
• Emotional distress
• Scarring or disfigurement
• Loss of enjoyment of life

As you can see, non-economic damages are more challenging to determine and often require an experienced personal injury attorney to negotiate a fair value.

Punitive damages

Punitive damages, or exemplary damages, are typically determined and awarded in a trial versus a settlement agreement. Punitive damages are not considered to be compensatory damages because their primary goal is not to reward the victim but rather to punish the defendant for reckless behavior in order to deter the individual from engaging in that behavior in the future.

Now that you have a clear understanding of the damages available in a personal injury settlement in Kentucky, let’s talk taxes.

Why most personal injury settlements in Kentucky are not taxable

The reason why most aspects of personal injury settlements are not subject to taxes is fairly straightforward. Settlements are not considered income.

The tax system is in place so that you pay taxes on gains. For example, capital gains would be considered taxable income, such as selling a house or other investments for a profit. Other taxable income is your ordinary income, like salaries and wages that you pay federal taxes and Kentucky state taxes on.

As explained, compensatory damages from a personal injury settlement are meant to compensate you for a loss. When you’ve been compensated for a loss, it is not viewed as income, but rather “making you whole” again or making up for the loss that the negligent party caused you to suffer.

Because a personal injury settlement is not considered gains, this means that they are generally exempt from Kentucky state and federal taxes.

Personal injury settlements that are not taxable

According to IRS code “26 USC 104: Compensation for Injuries or Sickness“, non-punitive damages received in personal injury settlements are excluded from gross income, regardless of whether they are received in a lump sum or staged settlement payments (smaller payments over a period of time).

Non-taxable damages recovered in a personal injury settlement include:

• Physical injuries or physical sickness
• Emotional distress or mental anguish
• Medical expenses and medical bills
• Pain and suffering
• Property damage

Let’s dive into each of these so that you can have a clear understanding of what each means in terms of taxes and some exceptions you may need to consider depending on your specific circumstances.

Personal physical injuries or physical sickness

If you receive a settlement for personal physical injuries or physical sickness, defined as “observable, bodily harm”, the full amount is non-taxable, assuming you did not take an itemized deduction for medical expenses related to the injury or sickness in prior years.

If you did receive a tax benefit in prior years by claiming the same medical expenses you recovered compensation for in your insurance settlement, the amount you claimed would be taxable. For example, let’s say you were the injured party in a car accident that happened in 2020, and each year you itemized those medical deductions on your tax return. When your car accident lawyer in Louisville reached a settlement on your behalf in 2024, you would be responsible for paying taxes on those previously deducted medical expenses from the prior three years.

This premise would be the same for the majority of case types and injury settlements a Louisville personal injury lawyer at our firm would handle, not just car accident cases.

Emotional distress or mental anguish

The financial compensation you recover for emotional distress or mental anguish is not considered taxable income and is treated the same as physical injury settlements. However, it is important to note that the emotional distress or mental anguish must be related to the physical injury or sickness.

An example where compensation for emotional distress or mental anguish is unrelated to a physical injury or sickness could be a case of defamation. Suppose someone spreads false and damaging statements about you, causing significant emotional distress but not resulting in any physical harm or sickness. In such a scenario, any monetary damages awarded as compensation for the emotional distress in a legal settlement or judgment would be considered unrelated to a personal physical injury or sickness and, therefore, taxable income.

Medical expenses and medical bills

Compensation you recover for medical expenses is not taxable. This includes past, present, and future medical bills related to the injury. Some examples of these expenses could include emergency medical bills, doctor care, medical devices, prescriptions, surgeries, lab work, or physical therapy, to name a few.

The exception to this would be if you previously deducted these expenses from your taxes. In this case, the compensation you recover might be taxable to the extent of the deductions you took.

Pain and suffering

Damages in a personal injury settlement for pain and suffering are non-taxable in Kentucky and on the federal level. Because Kentucky law does not cap the amount of damages available for pain and suffering, not being held liable for taxes on this money is especially beneficial given that the dollar amounts awarded can be very substantial.

Property damage

If you receive a settlement for the decrease in your property’s value, and the settlement amount is less than the adjusted basis of your property (which is the original cost plus any improvements or minus depreciation), it is not taxable. Additionally, you generally don’t need to report such settlements on your tax return because they are non-taxable.

For example, your car, which you bought for $20,000, suffered damages in a car wreck. After the accident, you spent $3,000 on repairs to restore its condition.

The adjusted basis of your car is now $23,000 ($20,000 + $3,000). If you receive a settlement for the decrease in the car’s value due to the accident, let’s say $18,000, since this amount is less than the adjusted basis ($23,000), it is not taxable.

Personal injury settlements that are taxed in Kentucky

Some personal injury settlement money you recover may be taxed in Kentucky and on the federal level.

What is taxable in a personal injury settlement can include:

• Lost wages and future lost wages
• Punitive damages
• Interest on a delayed personal injury settlement payment

Lost income

Lost wages are taxable damages in a personal injury settlement. This is because they are treated as a substitute for the wages you would have earned had you not been injured. Since you would have to pay taxes on the wages if you earned them while working, you will need to pay taxes on the settlement money you recover. Because lost wages are economic damages, this amount is fairly straightforward to calculate and leaves little room for interpretation.

Punitive damages

Punitive damages are awarded to punish an individual for gross negligence, a wanton disregard for public safety, or for intentional acts that resulted in a personal injury. In these cases, a judge may force the negligent party to pay punitive damages. Because punitive damages are meant to punish the defendant, versus “making the victim whole again”, they are generally taxable. You would report punitive damages as “other income” on your tax return.

Interest on personal injury settlement

Interest on a personal injury settlement can arise when there is a delay in receiving the full settlement amount. This interest can be made on the unpaid balance over time. In Kentucky, the interest rate is 6% from the date the settlement or judgement is entered.

Because this additional income goes beyond “making you whole again”, it is taxable.

In other states, this is different, such as Tennessee tax law for personal injury settlements.

Is a personal injury settlement for a minor taxable?

The important thing to understand about settlements awarded to minors is that Kentucky law requires that all settlements over $25,000 be placed into a blocked account. This keeps the funds inaccessible to the minor directly until they are 18 years old. This is referred to as a “restricted minors account”, as it also restricts parents or guardians from accessing the money unless given special permission by court order. The minor generally won’t pay taxes on the principal amount right away. However, the tax implications can differ depending on the types of damages awarded and how the funds are managed. It’s important to speak with a qualified tax professional regarding the exact tax implications for a minor.

How do I reduce personal injury settlement taxes?

A Kentucky personal injury lawyer can help you reduce the tax implications of a personal injury settlement in a number of ways.

• Properly allocating the settlement money into taxable and non-taxable categories can ensure that you only pay taxes on what you are required to.
• A personal injury attorney can help structure your settlement in a way that provides a steady income stream over time rather than receiving a payment in one lump sum.
• An experienced injury law firm can help with settlements awarded to minors by helping parents of minors understand the benefits of long-term structured annuities, which will protect the funds over time.

Let an experienced personal injury attorney in Kentucky get you the settlement you deserve

A Kentucky injury lawyer can help you recover damages in personal injury cases, help you understand what may be subject to taxes, and help reduce your taxes by ensuring that the compensation you recover is classified and categorized accurately.

Because the majority portions of personal injury settlements are non-taxable, it’s always beneficial for you to consult with an experienced personal injury attorney before you settle with the insurance company to ensure that you recover the most money possible.

If you’ve been injured, call us today for a free consultation.

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