Are Auto Accident Insurance Settlements Taxable?
If you received a settlement after being injured in a car accident, you may be wondering whether or not you have to pay taxes on it. The good news is, most car accident compensation is not taxable. However, depending on how your settlement is structured, you may owe taxes on a portion of it.
What Portions of My Settlement Are Taxable?
Compensation awarded after a car accident that may be taxable include:
Wage Reimbursement
Compensation for income lost during recovery and/or expected losses due to permanent injury. Lost wages are taxable under all circumstances. You must report it on your tax return even when part of an award, just as you would for a regular paycheck.
Medical Expenses
If a portion of your car accident settlement is for medical bills that you made deductions for in prior year(s), resulting in a tax benefit, then you will owe taxes on that compensation. If part of your settlement is for medical expenses across multiple years, you will have to pay pro-rata taxes on the total amount of medical expenses being reimbursed for each year they were listed as deductions.
Interest and Punitive Damages
“Immediate” compensation is rarely achievable after a car accident. Because there is an undesirable waiting period, victims’ attorneys will typically attempt to secure additional payment or interest on top of the lump sum. Any interest awarded is taxable.
Punitive damages are only awarded in cases involving a defendant who exhibited extremely reckless or egregious behavior. If this type of compensation is added to your settlement, you will owe taxes on it.
What Portions of My Settlement Are Not Taxable?
Medical Expenses
If you did not take any deductions on your tax returns for accident-related medical expenses, then the compensation you recover for your medical bills is not taxable income.
Property Damage
The compensation you recover for any property damage is not taxable income unless the amount you receive exceeds the property’s adjusted basis (net cost of an asset). In that case, taxes must be paid on the excess amount.
Pain and Suffering
The compensation you receive for your pain and suffering, and other non-economic losses related to a physical injury or illness you suffered, is not taxable. However, if your pain and suffering damages are linked to an emotional injury or psychological condition and do not involve a physical injury, the money is taxable.
Attorney Fees
Your attorney will typically take a percentage of your settlement as their contingency fee, but for tax purposes, you will be treated as having received 100% of the settlement. For example, if you settle a car accident case for $100,000, and your Las Vegas car accident lawyer keeps $40,000, you might think you’d have $60,000 of income, but you will still have to claim $100,000 in income. If your case is fully nontaxable, that shouldn’t cause any tax problems for you.
Lowering Your Tax Obligations
The taxes you will owe rely heavily on how your settlement is structured. Working with an injury attorney to ensure your settlement agreement clearly stipulates the amount of compensation allocated for each type of damages is critical. If your agreement is written up as a lump sum, it will be difficult to distinguish and prove how much compensation is taxable.