If you recently got into a car accident and received a settlement, whether for your medical bills and lost wages or simply just for property damage and repairs to your car, you may start wondering about what your taxes are going to look like when you report the additional cash flow. When the settlement is minor, like a $500 repair to your bumper, you might not feel much stress about it, but if you’ve been awarded a comprehensive settlement of something like $250,000, it’s completely understandable that you might be a bit anxious about what you’ll owe the IRS this year.
Well, there’s good news: a substantial amount of your auto insurance settlement is not taxable. That said, there are portions of a settlement that are taxable, so it’s important that you work with a tax specialist or an accountant to make sure you’re handling everything correctly.
Taxes On a Settlement After a Car Accident
Let’s get the big stuff out of the way first — what you do owe taxes on after a settlement.
Lost Wages
When you think about it, it’s obvious that you would owe taxes on the amount you received for lost wages since you would be earning those otherwise and would pay taxes on them as normal. If you’re not sure how to determine which portion of your settlement accounted for lost wages, you will want to speak with your attorney to gather all of the relevant documentation.
Suppose you typically use tax software like TurboTax or IRS Free File (for federal taxes only). In that case, you may want to work with an accountant for the year(s) that you are receiving payments for the wages you have lost due to your accident and subsequent injuries.
Punitive Damages
If you were paid in a settlement, this section would not apply to you because punitive damages are solely awarded by a judge or jury at the end of a civil lawsuit, and only in very rare instances at that. Punitive damages are awarded to a victim to punish (hence the name) the at-fault party in the personal injury case if they acted in a particularly egregious manner that caused your accidents.
Punitive damages are taxable because they are considered income, just like compensation for lost wages, and fall outside the bounds of standard personal injury damages.
What You DON’T Pay Taxes On
Now that we’ve gotten the taxable items out of the way, let’s look at what you don’t have to pay taxes on after a car accident settlement.
Compensatory Damages for Physical Injuries or Illness
This is the largest section of most settlements, and it’s also the least likely to be taxable. Anything that is awarded to you as a way to make up for physical injuries or illness that you incurred as a result of the accident is not considered taxable income. This includes money for:
- Any disability or disfigurement caused by the accident or injuries
- Lost enjoyment of life
- Any medical bills you incurred as a result of the accident, including future projected costs
- Property damage
- Assistive devices
- Ambulance fees
- Medications
In some cases, if you itemize your deductions on your taxes, you may be able to deduct any medical expenses that exceed 7.5% of your adjusted gross income (AGI). This is something you would want to discuss with your accountant or tax specialist.
Non-Physical Injuries
If you were awarded a settlement for emotional injuries that did not result in any physical manifestations, that money is also not taxable. This includes:
- Anxiety
- Depression
- Humiliation
- Mental anguish
- PTSD
- Shock
- Stress
- Trauma
If your emotional injuries did result in physical symptoms, like headaches or stomach problems, those would likely be considered physical injuries and would also not be taxable.
How To Reduce Your Tax Burden After a Settlement
Suppose you have reached an agreement with the insurer or at-fault party for an out-of-court settlement that may include payments for lost wages that extend many years into the future. In that case, you may want to consider a structured settlement that would give you the money in periodic payments rather than one lump sum.
The advantage of a structured settlement is that it would allow you to spread out the tax liability over several years as you receive the payments, which could help reduce your overall tax burden. You would still owe taxes on the taxable portions of your settlement as you received it, but it may be a more manageable amount.
The downside to a structured settlement is that you would not have access to the full amount of money right away, which could be a problem if you need the money to pay for ongoing medical treatment or other expenses related to the accident.
If you are considering a structured settlement, you should speak with your attorney and an accountant or tax specialist to see if it’s the right option for you.
Are Settlements for Property Damage Taxable?
If you think about an insurance claim as the process of seeking compensation to make you “whole” again, as in recovering compensation for losses that you have suffered, it makes sense that significant portions of the settlement are not taxable since you are not gaining, only breaking even.
One of those pieces that you are not taxed on is your property damage repayments since the money to repair your vehicle is not income, only a way of returning your vehicle (or belongings) to its previous state.
The same is true for any other property that may have been damaged in the accident, like a fence, home, business, or other structure.
In Doubt About Your Taxes After a Settlement? Talk To a Lawyer Today
While we hope this article has given you some clarity about what is and is not taxable after a car accident settlement, it is always best to speak with a personal injury lawyer in your state if you have any specific questions or concerns.
A good lawyer will be familiar with the tax laws in your state and can give you specific advice on how your particular settlement will be taxed. Additionally, if you are ever in doubt about the taxability of any portion of your settlement, you can always seek the advice of a tax specialist or accountant who can help you understand your specific situation.
1-800-Injured is a legal and medical referral service that connects personal injury victims with civil attorneys for a free consultation about their situation. If you or a loved one has been involved in an accident that someone else caused, contact us as soon as possible to connect with a personal injury lawyer who can help you make sense of your situation and fight for the compensation you deserve, whether through a settlement or a lawsuit.