Car accidents can cause you to suffer injuries, damage to your property, and emotional pain and suffering. Additionally, you may need time off work to recover from your injuries.
Fortunately, you should be legally entitled to seek compensation for your damages and losses. While this settlement should reimburse you for your expenses and losses, you might be wondering whether any settlement you receive is taxable. Today’s guide will highlight the taxable and non-taxable components of your settlement.
Is the Settlement You Receive from a Car Accident Taxable?
You will not pay tax on the full amount of a car accident settlement, assuming you didn’t use your medical as an itemized deduction, so you will not need to include the settlement when declaring income on your tax return. All compensation intended for lost wages is taxable as the wages would have been taxable.
In addition to lost wages, the following components of your personal injury settlement might also be taxable:
- Emotional pain and suffering
- Distress
- Punitive damages
The compensation you receive for medical costs is only taxable if you included those expenses on the previous year’s tax return. Any compensation you receive for physical sickness is not taxable, but compensation for emotional pain and suffering is taxable.
Due to the complexity of the laws and the number of exceptions to those laws, you should retain an experienced personal injury lawyer. An attorney can guide you through the intricate process of making a claim for compensation and can also help you meet your tax obligations to the IRS and the state department.
What Rule of Taxability Applies to Auto Accident Settlements?
Internal Revenue Code (IRC) Section 61 states that all amounts received from lawsuit settlements are taxable, whatever the source, unless exemptions apply. IRC Section 104 provides a number of exemptions, meaning not all components of your compensation will be taxable.
The salient issue here is what the settlement funds are intended to replace. If, like lost wages, the compensation is replacing what would have been taxable income, those settlement proceeds are taxable.
How can you get around paying tax on the whole personal injury settlement, then?
Can You Avoid Paying Tax on a Car Accident Settlement?
Most personal injury settlements will involve multiple legal issues, and your compensation may be intended for multiple purposes. As such, some components of your settlement will be taxable, while some will not attract tax.
Medical expenses are always tax-free, including any payments made to counselors, psychiatrists, and other mental healthcare professionals.
All settlement proceeds for punitive damages are taxable. Those damages are meant to punish the at-fault party rather than intended as compensation.
What Types of Car Accident Compensation Are Taxable?
The majority of judgements and settlements awarded in personal injury cases are typically meant as general damages and compensatory damages. Those damages categories include compensation for:
- Lost wages
- Medical expenses
- Emotional pain and suffering
Most victims of car accidents receive compensation for medical expenses and physical injuries, with the bulk of this compensation not subject to taxes.
Types of Damages
Personal injury settlements can include compensation for all of these components:
- Medical expenses
- Lost wages
- Non-economic damages
- Punitive damages
- Property damages
Medical expenses
In most car accident cases, victims suffering physical injuries seek compensation from the insurance company of the at-fault driver. Settlements for minor injuries and property damage can be a few thousand dollars, while compensation for serious car wrecks can run into hundreds of thousands, or even millions of dollars.
You are entitled to pursue compensation for these out-of-pocket medical expenses:
- Doctor’s visits
- OTC medications
- Prescription drugs
- Hospital stays
- Surgery
- Rehabilitation
- Assistive devices (wheelchairs or crutches)
Calculating damages for medical expenses involves adding out-of-pocket medical costs to any expected medical treatment.
None of the compensation received for physical injuries is subject to tax. It is not necessary to include this as income when filing your taxes.
Lost wages
All settlements compensating you for lost earnings are taxable.
Non-economic damages
Many accident victims find the cost of their physical injuries goes beyond the cost of immediate medical care. Severe accident injuries can trigger significant pain and suffering following the accident.
If you are awarded compensation for emotional pain and suffering, the amount of this compensation will depend on the severity of your injuries. Although the pain and suffering you are being compensated for is emotional, it stems from your physical injuries. As such, this component of your compensation is not taxable by the Internal Revenue Service.
Punitive damages
Most car accident claims do not include compensation for punitive damages. All punitive damages you receive will be taxable, though.
Property damages
The compensation you receive for damage to your property or vehicle is not taxable.
What To Do If You Sustain Injuries in an Auto Accident
You should retain an experienced personal injury attorney if you sustain injuries in a car accident.
A lawyer can help you to achieve a fair and reasonable settlement without necessarily needing to file a lawsuit. Also, your lawyer can explain how tax law might impact your settlement, safeguarding you from making a potentially costly mistake with the IRS.