As a victim of a road accident who has received or is about to receive a settlement or judgment for your injury and/or damages, you likely are wondering whether you will need to pay tax on the amount you receive. If it’s any consolation, you are not alone.
A majority of personal injury claims are settled out of court. But still, a few of them end up in trial, sometimes leading to a considerable jury verdict in favor of the victim. Whether you negotiate with the insurance provider or choose to take the case to court, one thing is constant – tax. The question becomes, are auto accident settlements taxable? That’s what we will be looking at in this article.
Auto accident settlements are often not taxed. According to the IRS, if you got a settlement or judgment for physical illness or injuries and didn’t take an itemized deduction for medical costs linked to the disease or injury in previous years, the whole amount is not taxable. Don’t add the compensation amount to your income. But there are exceptions – depending on the circumstances and nature of your judgment/settlement.
Please note that when it comes to taxes, settlement and judgment are viewed as the same thing. So it does not matter whether the compensation you got was at the claim stage or in the trial.
So, is your auto accident settlement taxable?
To answer this question, you will need to consider the reason for compensation – whether it’s pain and suffering, lost wages, wrong-doer punishment, medical costs and/or repair or replacement of damaged property. Basically, the amount you receive is for “general damages” and “compensatory damages” which cater to the expenses mentioned above.
In a typical settlement where you only get the general and compensatory damages for medical expenses and physical injuries, a majority of that amount is often not taxable. The reason is that this type of judgment or settlement is designed to reimburse you for the amount you paid from your pocket. Any compensation you get from car damages arising from the accident is also not subject to tax. This applies for repair costs along with any reimbursement you might have obtained for a rental vehicle while your car was undergoing repair
Any amount you get as compensation for lost wages is taxable, reason being, your income is taxable, and if you were not hurt, it would still be subject to tax. So, any amount that’s issued to replace the income is taxable too. If the amount includes compensation for other losses other than lost income, like pain and suffering and medical bills, you’ll still have to pay taxes on the portion of judgment or settlement that’s attributable to the lost income. In the rare event that you are awarded punitive damages in your settlement, you should know that these too are subject to tax.
Your attorney will inform you of the taxability of your settlement. However, keep in mind that not all personal injury lawyers are well versed with tax law. Finding a knowledgeable one will go a long way. Otherwise, you may want to get advice from a tax professional.