Are Car Accident Settlements Taxable By The State Dept of Revenue & IRS

Are Car Accident Settlements Taxable By The State Dept of Revenue & IRS?

If you are injured in a car accident and receive compensation for your injuries, damages, and emotional pain and suffering, you might wonder whether your auto accident settlement is taxable.

The laws concerned are involved and include many exceptions, so you should retain an experienced attorney to guide you through the process and to ensure you meet all your tax obligations to the state department of revenue and IRS.

Are Car Accident Settlements Taxable?

As long as you did not take an itemized deduction for your accident-related medical expenses, the full amount of your personal injury settlement is not taxable. As such, you do not need to include your settlement when you are declaring income.

That said, some components of a personal injury settlement can attract tax, though. These include:

  • Lost wages
  • Punitive damages
  • Emotional distress
  • Pain and suffering

Any compensation for lost wages is taxable. The wages would have been taxable, so any funds replacing those wages are also taxable.

Compensation received for medical expenses is only taxable if those expenses were included on your tax deduction for the previous year.

While compensation for emotional distress is taxable, damages for physical sickness do not attract tax.

What Is the Applicable Rule of Taxability for Car Accident Settlements?

Amounts received from the settlement of lawsuits, per IRC (Internal Revenue Code) Section 61, are taxable regardless of the source, unless exempted. This exemption is provided in IRC Section 104, although not all amounts received from personal injury settlements will be exempted.

The relevant issue when it comes to exemption is what was the settlement intended to replace.

How much, then, could you expect to pay in tax on a personal injury settlement?

How Much Tax Is Payable on a Personal Injury Settlement?

According to the US tax code, compensation received for punitive damages or emotional distress is taxable, while damages received for physical injury or physical sickness are not taxable.

The origin of the claim is central to taxes. If, for instance, you sue a third party for physical injuries you sustained due to the negligence of that party, the proceeds would not necessarily be deemed income.

Lawyer fees are counted as income, though.

Is it Possible to Avoid Paying Tax on a Settlement?

If your settlement involves multiple legal issues, you may have to pay tax on some components of your claim, but not on others.

Medical expenses will always be tax-free, including payments made to:

  • Psychiatrists
  • Counselors
  • Mental health professionals

When suing for punitive damages, both physical and emotional-related, the proceeds will always be taxable. Punitive damages are not meant as compensation, but rather to punish another party.

What Forms of Compensation Are Taxable?

Most settlements and judgments are intended as compensatory damages and general damages. Those categories of damages are meant as compensation for:

  • Medical expenses
  • Lost wages
  • Pain and suffering

In most car accident settlements, victims receive damages for physical injuries and medical expenses. The bulk of this amount of compensation should not be subject to taxes.

Different Types of Damages

A personal injury settlement may include compensation for any or all of the following:

  • Medical expenses
  • Non-economic damages
  • Lost wages
  • Property damages
  • Punitive damages

Medical expenses

Most car accident victims who suffer physical injuries seek compensation from the insurer of the at-fault driver. Settlements can run from a few thousand dollars into six or seven figures.

You are entitled to compensation for these out-of-pocket medical costs:

  • Prescription drugs
  • Over-the-counter medications
  • Hospital stays
  • Doctor’s visits
  • Rehabilitation
  • Surgery
  • Assistive devices like crutches or wheelchairs

Calculating damages for medical care involves totaling the cost of out-of-pocket medical expenses and any anticipated medical treatment in the future.

None of the compensation you receive for physical injuries is taxable, and you do not need to include this in your income.

Non-economic damages

You may find that the cost of your physical injuries extends beyond the simple costs of medical care. In many cases, accident injuries can trigger pronounced emotional pain and suffering in the aftermath.

Any compensation for emotional distress or pain and suffering is contingent on the severity of your car accident injuries.

While pain and suffering might be emotional, this stems from physical injuries and is thus not classified as taxable by the IRS.

Lost wages

Settlements compensating you for lost wages are taxable because your original wages would have been taxable.

Property damages

Money received in compensation for damage to your vehicle or property is not taxable, whether this is compensation for out-of-pocket repairs or for hiring a replacement vehicle.

Punitive damages

In most cases, a car accident settlement will not include punitive damages. This class of damages is designed to deter future misconduct by punishing the defendant.

Any punitive damages you happen to receive will be taxable.

What To Do After Suffering Injuries in a Car Accident

Trying to navigate the auto accident settlement process without experienced legal counsel representing you is likely to be challenging.

By retaining an experienced personal injury attorney, you can maximize your chances of receiving fair and reasonable compensation.

Beyond this, your lawyer can explain the impact of tax law on your settlement, ensuring you don’t make any potentially costly mistakes with the state department of revenue and IRS.

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