Most parts of a car accident settlement are not taxable. Reimbursement for your medical care, property damage, pain and suffering, and more cannot be taxed. Other elements of your settlement are taxable, including lost wages and punitive damages.
Accident victims may find tax law a bit complicated after they receive their car accident settlement. If you want to remain in good standing with the Internal Revenue Service (IRS), it’s important to understand which elements of your car accident settlement are taxable and which are tax exempt.
Fortunately, working with a knowledgeable car accident attorney can help. An attorney understands the ins and outs of insurance settlements — as well as related tax law — and can save you time and stress come tax season. Here’s how you can decide if your car accident settlement is taxable.
Do You Have to Pay Taxes on Insurance Settlements?
Tax law in the United States does not explicitly state whether or not accident victims must pay taxes on insurance settlements. The law dictates that taxation relies on the types of damages and the subsequent types of compensation the accident victim received. To best understand if you will have to pay taxes on your insurance settlements, it’s helpful to start with the purpose of insurance.
After an auto accident, the insurance company’s role is to help make the victim ‘whole’ again. An insurance settlement should help restore a victim to the state they were in before the crash, both physically and financially. In other words, an insurance settlement should cover medical expenses for a physical injury and ensure the victim is not in debt from lost income or vehicle repairs.
On the other hand, taxation is meant for income — money received that makes an individual wealthier than they were before. Since the purpose of insurance is to make a victim whole and not wealthy, most insurance settlements are not taxable. For instance, an accident victim does not need to pay taxes on reimbursement for medical bills and property damage.
This is not the case for reimbursement for lost wages. Lost wages are a type of income that an accident victim would have received if not for the accident injury. Since this income would have been taxed regardless of the accident injury, an accident victim does need to pay taxes on lost wages in a personal injury claim.
Parts of Car Accident Settlements That Are Not Subject to Taxes
Taxation for car accident settlements is based on the ‘origin of the claim’ or if the purpose of the settlement was for income.
Reimbursement for a car accident victim who filed a personal injury insurance claim or lawsuit due to another driver’s negligence would not be considered income. These damages compensate a victim for physical sickness or injury, so they are considered tax-free.
Compensatory damages in a personal injury case that are not taxed include:
- Ambulance rides
- Prescription drugs
- Medical bills and expenses
- Hospital and doctor’s visits
- Over-the-counter medication
- Psychiatrist or counselor visits
- Physical therapy or rehabilitation
- Assistive devices, such as a wheelchair
- Property damage, such as vehicle repair costs
In addition to compensatory damages, which reimburse accident victims for out-of-pocket bills and expenses, a variety of general damages can be included in a personal injury case. The most common type of general damages after a car wreck is pain and suffering. Compensation for suffering caused by a physical injury sustained in an accident cannot be taxed.
Parts of Car Accident Settlements That Are Subject to Taxes
Certain damages included in a car accident settlement are taxable, namely those that are not compensatory.
These damages do not recompense an accident victim for out-of-pocket expenses or losses. This means the IRS considers these damages to be income. And income is all taxable according to the IRS.
Damages in a personal injury case that are taxed include:
- Lost wages
- Punitive damages (compensation awarded to punish the at-fault driver)
A common gray area in tax law for car accident settlements is whether the accident victim received a previous tax deduction for medical expenses related to the injury. If an accident victim received an itemized deduction for medical bills that resulted in a tax benefit, the settlement amount for the injury case could be taxed on a pro-rata basis.
Is It Possible to Reduce Car Accident Settlement Taxes?
Unfortunately, an accident victim cannot negotiate settlement taxes with the IRS. Even personal expenses like attorney’s fees are included in your car accident settlement taxes.
If an accident victim receives a $100,000 personal injury settlement and pays their attorney $30,000, the victim’s “total income” is still considered $100,000, not $70,000.
This poses an issue for large settlements. If your insurance settlement is a substantial amount (such as one that covers many years of future lost wages), you can speak with your car accident lawyer about opting for a structured settlement.
A structured settlement means that your compensation is paid out over an extended period of several years rather than in one lump sum.
This way, you can exclude some of the income deductions from your current taxes. Your car accident lawyer will work with the insurance company to establish an annuity for your benefit that may ultimately save upwards of 25% of settlement taxes.
Are You Required to Claim a Personal Injury Settlement on Your Taxes?
If you received a personal injury or personal sickness insurance settlement and did not receive an itemized deduction for medical expenses, the total amount of your accident settlement is not taxable. This means you are not required to claim your car accident settlement on your tax return when declaring your yearly income.
If you received a personal injury claim for lost wages, you are required to report that portion of the settlement on your taxes when declaring your yearly income because lost wages are a type of income. Likewise, if you received an itemized deduction for medical expenses related to the incident on previous taxes, you must claim your settlement on your taxes.
Tax law is applicable whether you received your personal injury settlement out of court via the insurance company or if you were awarded compensation from a civil court after a trial. If you require assistance navigating income tax or tax law after a personal injury claim, it is highly recommended you receive a free case evaluation from a personal injury lawyer.
Why Should You Get an Attorney to Help with Your Auto Accident Settlement?
It’s no secret that receiving an auto accident settlement can be confusing. As you navigate negotiations with the insurance company, consider consulting a personal injury attorney for legal advice. A respected personal injury attorney can fight for your right to fair compensation so that your settlement can make you whole again and ensure you’re not left in debt.
Once you receive compensation, an attorney can help explain the nuances of tax law and whether your unique car accident settlement is taxable. With taxation depending on the type of damages and compensation received, an attorney will review each aspect of your settlement to protect you from making a grave mistake with the IRS and your yearly tax return.
If you’ve been injured in a car accident, now is the time to reach out to a law firm you can trust. David Bryant Law provides top legal services to accident victims across the state to ensure that every client has an equal opportunity to fair compensation and a clear understanding of tax laws. Contact David Bryant Law today for a free consultation. We look forward to hearing from you.