Are Personal Injury Settlements Taxable in South Carolina? What Charleston Plaintiffs Need to Know

One of the most common questions injured South Carolina clients ask is whether their personal injury settlement is taxable. The good news is that most of it is not — but the exclusion has important limits that can create unexpected tax liability if a settlement is not structured properly.

The Federal Rule: IRC § 104(a)(2)

The starting point is 26 U.S.C. § 104(a)(2), which excludes from gross income "damages (other than punitive damages) received (whether by suit or agreement) on account of personal physical injuries or physical sickness." The Supreme Court's decision in Commissioner v. Schleier clarified that the exclusion applies only to compensation received on account of a physical injury — a limitation that has significant practical consequences for how settlements are allocated.

What Is and Is Not Excluded

• Excluded (not taxable): Compensatory damages for physical injuries and physical sickness — including medical expenses, lost wages, pain and suffering, and disability damages — are excluded from federal gross income when they flow from a physical injury claim. This covers the vast majority of a typical car accident, slip-and-fall, or workplace injury settlement.
• Not excluded (potentially taxable):
  • Punitive damages — explicitly carved out by the statute. If a settlement allocates a portion to punitive damages, that amount is includable in gross income.
  • Interest on a judgment or settlement — taxable as ordinary income regardless of the underlying claim.
  • Emotional distress damages not arising from a physical injury — pure emotional distress claims unconnected to physical injury are taxable. However, emotional distress damages that flow from and are connected to a physical injury typically qualify for the exclusion.
  • Lost wages in employment discrimination cases — settlements in EEOC or Title VII cases involving purely economic discrimination (with no physical injury) are taxable, because they are not received "on account of personal physical injuries."

Why Settlement Allocation Matters

When a settlement covers multiple types of damages — compensatory, punitive, and interest — the allocation between taxable and non-taxable components directly affects the plaintiff's tax liability. A settlement agreement that does not specify the allocation may result in the IRS taking a position that is adverse to the plaintiff. For significant settlements, working with both a personal injury attorney and a tax advisor to document the allocation in the settlement agreement is advisable.

Structured Settlements: A Tax Planning Tool

A structured settlement — in which the defendant purchases an annuity that pays the plaintiff in installments over time — preserves the IRC § 104 exclusion on each payment, including the "earnings" component that would otherwise be taxable if the plaintiff received a lump sum and invested it. For larger settlements in catastrophic injury cases, structured settlements can provide meaningful long-term tax benefits alongside the certainty of future income.

How Traywick Law Helps

Our office advises clients on settlement structure and allocation as part of the overall representation in Charleston personal injury cases. Visit the Traywick Legal Blog for more analysis.

Talk to a Charleston Attorney

If you have questions about how this issue affects your situation in Charleston, Mount Pleasant, or anywhere in the Lowcountry, contact Traywick Law Offices for a free consultation. Call (843) 343-5092.

Disclaimer: This article is provided for general informational purposes only and is not legal advice. Reading it does not create an attorney-client relationship. Every case is different — please consult an attorney about your specific situation.

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