Most Houston personal injury settlements are not taxable. Texas has no state income tax, so you will never owe state taxes on your settlement. At the federal level, the IRS excludes compensation for physical injuries or physical sickness from taxable income under Internal Revenue Code Section 104(a)(2). This means money you receive for medical bills from Memorial Hermann or Ben Taub, pain and suffering from a physical injury, and physical impairment is tax-free. However, there are important exceptions. Punitive damages are always taxable at the federal level because they punish the defendant rather than compensate you. Interest that accrues on a settlement is taxable. Emotional distress damages not tied to a physical injury may also be subject to federal income tax. Lost wage portions of a settlement can be taxed in some circumstances because they replace income that would have been taxable. How your settlement agreement is worded and allocated matters significantly for tax purposes, so work with your Houston attorney and a tax professional to structure the payout in a way that minimizes your liability.