At 68 He’ll Win a $200,000 Settlement After a Car Crash. The Injury Money Is Tax-Free, but the Interest Isn’t
A $200,000 crash settlement sounds like a clean win, but one small line item can quietly reach into a retiree's Social Security checks. Before signing, find out which part of the payout the IRS still wants to count.
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After a car crash and a long recovery, he finally gets the call at 68: the case settled for $200,000. After the relief comes the truly important question: How much of it goes to the IRS?
Most of the time, very little of the injury money is taxed. The interest is where retirees get caught, because a small amount of taxable interest can affect how much of their Social Security gets taxed and what they pay for Medicare. Many people in their late 60s end up in this exact spot after a crash, a fall, or a medical injury.
Why the Injury Money Stays Off His Tax Return
Federal law excludes “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness”. Put simply, money paid because your body got hurt isn’t income.
Emotional distress follows the injury. Damages for emotional distress due to a physical injury or sickness are treated as received for the physical injury, so they’re tax-free too. Distress with no physical injury behind it is a different story. Think discrimination or damage to your reputation. You must include that money in income.
Three Parts of a Settlement That Can Get Taxed
- Interest. IRS guidance lists interest on any award as ordinary income. That’s true even when the award it’s based on is tax-free.
- Punitive damages. These are money meant to punish the other side. They’re taxable in most cases, and the IRS says it doesn’t matter whether they relate to a physical injury.
- Medical bills you already deducted. If you itemized and wrote off crash-related medical costs in an earlier year, the portion of the settlement that reimburses you for them can count as income. The law carves out amounts tied to deductions allowed under section 213 in prior years. If that earlier deduction didn’t lower your tax, though, you don’t owe tax on the recovery under the tax benefit rule.
Legal fees can make this worse. When part of the recovery is taxable, the IRS counts attorney fees and costs (including contingent fees) on that part as your income. Discrimination cases get a special deduction for those fees. Car crash cases don’t.
How Taxable Interest Can Raise His Medicare and Social Security Costs
Money excluded from income never shows up in adjusted gross income, which is the income number at the center of your tax return. That keeps the injury money out of both retirement tests. The interest still counts toward both.
Social Security comes first, and to calculate how much is taxable, the IRS generally adds half your benefits to your other taxable income and any tax-exempt interest. If that total tops $25,000 for a single filer or $32,000 for a married couple filing jointly, part of the benefits can become taxable.
Medicare is next, as the IRMAA surcharge uses your AGI plus tax-exempt interest income. It looks back about two years, so 2026 premiums are generally based on 2024 tax return information. In 2026, single filers above $109,000 pay $284.10 a month for Part B instead of the standard $202.90.
Suppose he puts the money into a CD paying somewhere around the national average of 1.76%, which works out to about $3,520 a year on $200,000. Top online banks often pay around 4 to 4.5%, which could earn him substantially more. All of it is taxable interest. For a typical retiree, that’s nowhere near IRMAA territory, but it can push more Social Security into the taxable zone (one of nine quiet IRS rules we mapped in a free retiree tax trap guide). He should plan for it before the 1099 shows up.
Read the Settlement Wording Before Signing
The IRS decides how to tax a settlement by looking at what the settlement replaces. The agreement is your best evidence of what that was.
Check that it ties the payment to physical injury and lists any interest or punitive amounts separately. Vague wording leaves the IRS room to guess, and they won’t guess in your favor.
Structured settlements, which pay out over years instead of all at once, stay tax-free under the same periodic payments language. The catch is that those payments generally cannot be accelerated, deferred, increased, or decreased.
At 68, with medical bills sitting there and only $200,000 at stake, most people do better taking the full payout upfront and keeping control of it. Larger cases that require lifelong care are where a structure earns its worth.
What to Do in the First Six Months
Pay off the medical bills and any debt the recovery piled up. Then rebuild the emergency fund that the crash probably drained. Put the rest somewhere safe and boring, like Treasury bills or CDs, and keep each bank’s deposits within FDIC insurance limits. We’ve covered all three in separate guides.
Don’t make big moves for a few months. Buying a house, giving money to family, or buying an annuity can all wait until the uncertainty settles. A lump sum in a checking account feels urgent. It isn’t.
Keep This One Document Forever
File the signed settlement agreement somewhere permanent. If the IRS ever asks why $200,000 wasn’t reported as income, the settlement agreement and supporting records can show the payment was for physical injuries. Before you sign, check that the interest is broken out on its own line, and plan to report it.
Contact [email protected] for any questions or corrections.
David Beren has been a Flywheel Publishing contributor since 2022. Writing for 24/7 Wall St. since 2023, David loves to write about topics of all shapes and sizes. As a technology expert, David focuses heavily on consumer electronics brands, automobiles, and general technology. He has previously written for LifeWire, formerly About.com. As a part-time freelance writer, David’s “day job” has been working on and leading social media for multiple Fortune 100 brands. David loves the flexibility of this field and its ability to reach customers exactly where they like to spend their time. Additionally, David previously published his own blog, TmoNews.com, which reached 3 million readers in its first year. In addition to freelance and social media work, David loves to spend time with his family and children and relive the glory days of video game consoles by playing any retro game console he can get his hands on.
