Last updated: 14 October 2026
Is compensation for a work-related injury taxable or tax-deductible?
For the employee, compensation for a personal injury, whether paid by the employer, an insurer or awarded by a court, is tax-free. That includes damages for pain and suffering and for loss of future earnings. For the employer, compensation paid to an injured employee, and the employer’s liability insurance premiums, are normally allowable business expenses. The exception is where a payment is really contractual pay, such as sick pay during absence, which is taxed through payroll as earnings.
Tax treatment
| Payment | Taxable on employee? | Deductible for employer? |
| Personal injury damages | No | Yes, if paid by the business for a trade injury |
| Out-of-court settlement for injury | No | Yes |
| Statutory and contractual sick pay | Yes, through payroll | Yes |
| Industrial Injuries Disablement Benefit | No | n/a |
| Payment on termination due to injury or disability | Exempt in full under the disability exemption | Yes |
| Interest on a court award | Yes, savings income | n/a |
The disability exemption on termination
Payments made on termination of employment because of injury or disability are fully exempt from income tax, not just the first £30,000. The injury or disability must be the reason for the termination, supported by medical evidence. Payments that are really for loss of office or pay in lieu of notice don’t qualify.
Example
Andy is injured at a warehouse when a shelf collapses. His employer’s insurer pays him £45,000 in damages. None of this is taxable. Andy receives Statutory Sick Pay during 6 weeks off, taxed through payroll. Later, he can’t return to his old role and his employment ends with a £25,000 payment because of his injury, which is fully exempt under the disability exemption. The employer deducts the sick pay and any uninsured compensation from its profits.
Self-employed people
If you’re self-employed and receive compensation for an injury, the damages are tax-free. Payments under business interruption or income protection insurance taken out by the business are taxable as trading income.
For employers
- Employer’s liability insurance is a legal requirement and deductible
- Uninsured compensation payments for injuries at work are normally deductible
- Legal costs of defending injury claims are deductible
- Report serious injuries to HSE under RIDDOR
Common mistakes
- Putting injury damages through payroll
- Missing the disability exemption on termination
- Treating income protection payouts as tax-free when the business paid the premiums
- Not reporting interest on a court award
Records to keep
Keep the settlement agreement, medical evidence, insurer correspondence and payroll records showing sick pay.
Payments while you are off work
If your employer tops up your pay while you recover, or pays you under a permanent health insurance policy it holds, those payments are earnings and go through payroll. If you bought an income protection policy yourself with your own money, the payouts are tax-free. The difference depends on who paid the premiums and who receives the policy benefit.
Frequently asked questions
Is compensation for lost earnings taxable?
Not if part of personal injury damages.
Do I pay NIC on injury compensation?
No.
Can a director get the same treatment?
Yes, if the payment is genuine compensation.
Does compensation affect benefits?
It may, though personal injury trusts can protect means-tested benefits.
Related: incapacity and sickness benefits, statutory sick pay for an injured employee and UK tax on a payout.
Talk to Accotax
Want this handled for you? Our team at Accotax can help with employment injury payments. See our payroll services service, or contact us for a free, no-obligation quote.
This page is general guidance based on HMRC rules for the 2026/27 tax year, checked against gov.uk on 14 October 2026. It is not personal advice, so speak to an accountant about your own situation.
