Personal injury compensation is tax-free — no Income Tax, no CGT, no IHT on the compensation itself. But interest on the award, and any income generated by investing the proceeds, are taxable in the normal way. Here is the complete picture in 2026/27.
Tax Treatment of Personal Injury Compensation at a Glance
| Element | Taxable? | Notes |
|---|---|---|
| Lump sum compensation | No | Exempt under s.731 ITTOIA 2005 and s.51(2) TCGA 1992 |
| Periodic payments (structured settlement) | No | Each payment fully exempt |
| Interest on the award | Yes | Taxed as savings income |
| Investment returns on invested compensation | Yes | Normal Income Tax / CGT rules apply |
| Inheritance: compensation passed on death | Potentially | Depends on estate value — normal IHT rules |
| Compensation in a personal injury trust | Protected | Disregarded for means-testing |
Why Personal Injury Compensation Is Tax-Free
The exemption rests on the principle that compensation restores a loss — it does not create a profit or additional income. Parliament has specifically legislated this:
- Income Tax: s.731 Income Tax (Trading and Other Income) Act 2005
- CGT: s.51(2) Taxation of Chargeable Gains Act 1992
The exemption applies to awards for:
- Physical injury (accident, assault, clinical negligence)
- Psychological injury (PTSD, psychiatric harm)
- Industrial disease (asbestosis, vibration white finger, industrial deafness)
- Fatal accidents (awards to dependants under the Fatal Accidents Act 1976)
Interest on Personal Injury Awards: Taxable
Courts routinely award interest on top of personal injury compensation — both on special damages (quantified losses like lost earnings and medical costs) and sometimes on general damages (pain, suffering, and loss of amenity).
The interest element is taxable as savings income. It falls within the Personal Savings Allowance:
- £1,000 tax-free for basic rate taxpayers
- £500 tax-free for higher rate taxpayers
- £0 for additional rate taxpayers
Example: Michael settles a claim for £250,000, comprising £235,000 compensation and £15,000 interest. The £235,000 is tax-free. The £15,000 interest is taxable savings income — after his £1,000 PSA, £14,000 is taxable at 20% = £2,800 Income Tax.
If your settlement does not separately identify the interest, ask your solicitor for the breakdown. You need this to complete your Self Assessment return correctly.
Investing Personal Injury Compensation
The compensation is tax-free to receive — but once you invest it, the proceeds are fully within the tax net:
| Investment | Tax on returns |
|---|---|
| Bank / savings account | Interest above PSA taxable |
| ISA | Tax-free — use your £20,000 annual allowance |
| Stocks and shares | Dividends above £500 allowance taxable; CGT on gains above £3,000 AEA |
| Property | Rental income taxable; CGT on sale |
| Annuity (structured settlement) | Tax-free (court-ordered only) |
The ISA allowance (£20,000/year in 2026/27) is the obvious first destination for compensation being invested — interest and gains within an ISA are always tax-free.
For larger awards, spreading investment into ISAs over multiple years (£20,000 per tax year) progressively shelters the capital from tax on returns.
Personal Injury Trusts: Protecting Means-Tested Benefits
If you receive personal injury compensation and also claim means-tested benefits (Universal Credit, Housing Benefit, Council Tax Reduction), the capital will normally be assessed after 52 weeks — potentially reducing or eliminating your entitlement.
A personal injury trust (also called a special needs trust) is a legal structure that holds the compensation separately from your personal assets. Capital and income within a properly constituted personal injury trust is permanently disregarded for means-testing purposes.
Key features:
- Must be set up within 52 weeks of receiving the compensation to benefit from the disregard
- Requires at least one trustee in addition to the beneficiary
- Does not eliminate Income Tax on investment returns within the trust — a trustee tax position still applies
- Costs: typically £1,500–£3,000 to set up via a solicitor
Structured Settlements: Every Payment Tax-Free
Where a court orders a structured settlement under the Damages Act 1996, the defendant’s insurer purchases an annuity that makes regular tax-free payments to the claimant for life (or a fixed period). Unlike an ordinary annuity — where part of each payment is taxable income — structured settlement payments are entirely tax-free in the hands of the recipient under s.731 ITTOIA 2005.
This is a permanent, statutory exemption — it is not affected by future changes to Income Tax rates or allowances.
Do I Need to Declare Compensation on My Tax Return?
No — tax-exempt personal injury compensation does not need to be declared on your Self Assessment return. You declare only the taxable element (interest on the award). If you are not otherwise required to file a Self Assessment return, you may need to register to report the interest if it exceeds your PSA.
See our savings tax guide, ISA allowance guide, and income tax guide.