Punitive Damages are the one exception to the rule that personal injury damages are not taxable. If you receive punitive damages in your case, you must pay income taxes on this money. According to IRS Publication 4345, you must report punitive damages on your tax return as other income. Since they are income on your federal tax return, they will also be income for the state, and you will need to pay both federal and state income tax on punitive damages.
In theory, punitive damages are not part of your physical injury. Instead, they are connected solely with the defendant’s actions. The jury wants to punish them for what they did because it was shockingly bad. In this case, punitive damages may be a windfall for you, and they are taxed.
However, punitive damages are very rare in a personal injury case. The courts only award them when the jury wants to send a strong message to a defendant who has done something seriously wrong. Punitive damages cover egregious acts of carelessness or recklessness that a jury wants to punish - hence the name punitive damages. You will not receive punitive damages in a settlement. In fact, the prospect of paying punitive damages is a primary reason insurance companies want to settle some cases before they reach a jury.