When it comes to car accidents and personal injury claims, a common question clients have is whether or not the IRS can tax money received in settlement of their claims. So is a car accident settlement taxable? Unfortunately, there are types of damages recovered in car accident settlements that the IRS will tax, but there are also tax-exempt damages.
No one likes paying taxes, but you may need to pay taxes on certain damages you receive. Otherwise, the IRS may audit and reprimand you. The IRS will tax amounts you receive from the settlement of your claim when you have gained money and not when you’ve been reimbursed for bills you paid. This is an important distinction because there are some forms of damages you could receive in a car accident settlement that are meant to reimburse you, while others are non-compensatory.
In this blog, we discuss the types of damages that are taxable, damages that are tax-exempt, structured settlements, and how deductions may impact the amount of taxes you owe the IRS after receiving a car accident settlement. However, you should contact a tax accountant prior to settling your claim to receive professional advice about any amounts of the settlement you receive that will be taxed.
What Forms of Damages are Tax-Exempt?
When damages are intended to reimburse you, they’re typically tax-exempt.
You do not need to pay taxes on compensation for property damage and medical bills. Because these damages are meant to reimburse you, you’re not in a more financially advantageous position than before your wreck — the damages are only meant to reimburse expenses you’ve already paid because of your wreck.
What Car Accident Settlement Damages are Taxable?
Amounts your receive in settlement for lost wages are considered taxable. It is just like the taxes you pay on the money you earned at work when you’ve not been injured in a car accident.
If you receive a judgment for damages from a court, and the amount includes any interest, that interest amount is taxable.
Additionally, non-compensatory damages that can be awarded by jury, for example, punitive damages, are considered taxable. Punitive damages are technically not part of car accident settlements or damage awards. Those damages are designed to punish the defendant rather than reimburse the plaintiff.
Pain and Suffering and Emotional Distress
“Pain and suffering” is a term referring to physical pain, mental anguish, and emotional stress you may have experienced because of your personal injury. Damages received in settlement of your pain and suffering that directly results from the injury you suffered is tax-exempt. However, damages received in settlement for emotional pain and suffering that resulted from the accident itself are not tax-exempt.
For example, if you experience physical pain or you develop a mental illness (such as depression) as a result of your physical injury, you would not need to pay taxes on the damages. In contrast, if you develop anxiety because of the wreck itself and not because of your physical injury, those damages you receive are taxable.
You may be able to reduce the amount of taxes you owe on the taxable damages to be paid to you through a structured settlement. For example, a structured settlement can spread out the money you’ll receive for taxable lost wages over the course of years rather than receiving a lump sum.
When you choose a structured settlement, the insurance company will purchase an annuity for your benefit. That annuity will receive interest income of the duration of the annuity. A structured settlement pays out a portion at certain intervals in time. Part of the money you are receive is interest, while the other part is from the principal amount the insurance company paid to purchase the annuity. The interest portion of the payment is tax-exempt, but you will need to pay taxes on the non-interest portion of the payments. Under this method of settlement, you could save up to 35% on taxes.
How Tax Deductions Impact Your Damages
It may take several years from the time you assert your personal injury claim to the time you receive the settlement funds. In terms of the medical expenses you paid during that time for treatment of your injuries, you may have chosen to take itemized tax deductions for any of those tax years. The amount of those particular deductions will be taken into consideration when determining the amount of taxes owed on the medical expenses recovered in the settlement. Your medical expenses settlement will be taxed to the extend of the deductions you took for those medical expenses. The rest of the the medical expenses settlement you received is not taxed because you were reimbursed.
Contact a Western Kentucky Car Accident Attorney
Navigating car accident settlements can be confusing, especially if you’re also recovering from an injury. Don’t go through the process alone — contact a car accident attorney to assist you with your claim.
If you need assistance with a car accident or personal injury claim in Western Kentucky, contact Rhoads & Rhoads Injury Lawyers. We have 150 years of combined experience helping Kentucky residents receive the money they deserve from car accidents and other causes of personal injuries. Contact our office at 888-709-9329, or contact us online here.