If you’re in the process of filing a car accident claim or have received your settlement, you’re probably wondering whether the money is taxable. The answer is, it depends on what that total amount includes.
Car accident settlements are generally not taxable because benefits arising from physical injuries are excluded from federal income tax. But if your settlement includes lost income or punitive damages, that portion of the sum will be taxable.
Let’s break it down.
How Does Taxation Affect Your Car Accident Settlement?
IRS Section 104(a)(2) excludes from gross income “the amount of any damages (other than punitive damages) received on account of personal physical injuries or physical sickness.”
In plain terms, compensation intended to reimburse you for the impact of your injuries arising from the car accident will not be taxed. Punitive damages are not paid on account of your injuries. They are paid to punish the defendant for their reckless actions. That’s why punitive damages are taxed.
Let’s see how taxation applies to each part of your settlement.
1. Settlement for Medical Bills
Settlement for medical expenses is the sum total of the amount of money you pay to treat your personal injuries. Since this is an amount you would otherwise have had in your bank account had the accident not occurred, it’s not treated as new income. So, income tax does not apply here.
2. Settlement for Pain and Suffering
While emotional distress does not count as physical injuries, the compensation you receive for it is excluded from taxation according to IRS Section 104(a)(2). The logic here is that you only suffered emotionally as a result of the physical injuries.
3. Settlement for Other Out-of-Pocket Expenses
This includes money spent on transportation to the clinic, hiring assistance to help you at home, and other necessities resulting from your injuries. Since you’re simply being reimbursed, this settlement is also not counted as income and will not be subject to income tax.
4. Settlement for Lost Income
The money you receive for your lost wages after a car accident is taxable. Why?
Suppose the crash never happened. You would have earned that same amount. And income tax would have been deducted. It then follows logically that this same income tax should be deducted when you later receive the lump sum.
5. Settlement for Car Repairs
The payout you receive for car repairs or replacement after a crash is not taxable.
6. Punitive Damages
It’s rare for car accident victims to be awarded punitive damages. It usually comes up when the at-fault driver behaved not merely negligently but absolutely recklessly, putting the lives of other road users in danger. To discourage such behavior among motorists, guilty parties are made to pay punitive damages to the victims.
In the rare event you are awarded punitive damages, be aware that the amount is going to be subject to income tax.
Since every car accident is different, the grounds for punitive damages are not always set in stone. Your car accident lawyer will evaluate the circumstances surrounding the crash to determine what damages are worth pursuing so you can keep your expectations realistic.
7. Interest on Settlement
In the event that the defendant fails to pay you on time, the settlement amount may accrue interest. This interest will be subject to taxation. You should report it on your income tax return.
Final Verdict: Do You Owe Taxes on Your Car Accident Settlement?
No, not if your settlement does not include lost income or punitive damages. Compensation for medical bills, property damage, out-of-pocket expenses, and pain and suffering is not taxable.
If you’re ever unsure, it doesn’t hurt to speak to your Aurora car accident lawyer to help you confirm what exactly makes up your car accident settlement and whether you need to report any of it to the IRS.
