Getting injured in a car accident can be a life-altering experience. If the crash happened because of someone else’s negligence, the law is on your side. You can seek damages from the at-fault party for your injuries and losses. You can file a claim through your personal injury attorney and demand financial compensation for:
- Medical expenses, which might include everything from emergency treatment to long-term therapy
- Current and future wages you could not earn because of your injuries
- Compensation for any lasting disabilities or disfigurement
- Compensation for the physical pain and suffering you endured
- Compensation for emotional and mental stress
- Reimbursement for all the expenses that came up due to the accident, the injury, or the time it took to recover
One of the common concerns injured victims and their families may have is whether the car accident settlement amount they receive will be taxed. In general, car accident insurance settlements do not have any impact on your tax bill. However, there are exceptions to this rule which a knowledgeable car accident lawyer can explain to you.
What Does the IRS Say?
The taxation rules are almost the same, whether you get a settlement outside of court from the car insurance company or if a civil court awards you money after a trial. As per the 26 C.F.R section 1.104-1(c), the Internal Revenue Service (IRS) states that if you receive compensation for personal physical injuries or sickness, this amount is NOT included in your taxable income.
This applies whether you obtained this money through a lawsuit or a settlement, and it does not matter if it is a lump sum or in installments. However, money for emotional distress is not excluded unless it is directly linked to a physical injury or sickness. Most states, including Indiana, follow these tax laws when it comes to personal injury settlements and judgments.
Let’s take a closer look at what is taxable and what is not under the federal tax law:
Compensation for medical treatment and care
Most of the money awarded in car accident settlements and judgments is for compensatory damages and general damages, which are meant to cover your emergency room and hospital bills, surgeries, prescription medications, lost earnings, and the physical and emotional pain resulting from your injuries.
In settlements where you get compensatory and general damages specifically for your injuries and treatment costs, this money is not taxed – provided you have not used those medical bills as deductions on your tax returns and they are related to injuries from the accident.
However, if you did use those expenses for tax deductions and got a benefit from it, the IRS may tax some or all of the car accident insurance settlement related to these expenses.
Compensation for lost wages
The part of your auto accident settlement that compensates for the income you lost due to not being able to work (because of your accident injuries) is taxable. This is because it is replacing the lost income you would have earned and reported as taxable income if the injury had not occurred. So, the tax system treats this compensation as if it were your regular salary or wages.
Compensation for pain and suffering
The compensation you get for the physical pain, stress, and emotional distress caused by the traumatic accident, is not taxed if it is directly related to an injury or illness caused by the crash. The IRS does not count this for car accident settlement taxes because this compensation is a restoration for what was lost due to the injury, rather than income; it is seen as a reimbursement for personal loss.
However, if emotional distress damages are not directly linked to a physical injury (i.e., they are for psychological trauma alone), they may be taxable.
Compensation for punitive damages
These are taxable. Unlike compensatory damages (which are meant to reimburse for a loss), punitive damages are intended to punish the wrongdoer for extremely thoughtless or intentional actions that put others at risk. Since they are not linked to a specific personal loss or injury, the IRS treats punitive damages as taxable income.
Other damages
Besides the compensation listed above, you may also be able to recover the cost of repairing/replacing your vehicle, not being able to use your car, and out-of-pocket expenses such as transportation to-and-from the hospital, hiring babysitters or help for household chores, etc.
These are generally not taxable, but if you declared these as deductions on your tax return, the settlement amount covering these specific losses might be taxable. You should consult with a car accident attorney or an income tax professional who has experience with determining how lawsuit compensations are taxed.
Are Car Accident Settlements Taxable? Consult with Our Experienced Personal Injury Attorney Today
The way your personal injury settlement agreement is worded can influence whether or not you have to pay taxes on the money you receive. The wording in your car accident settlement paperwork specifies what each portion is meant for, and the IRS looks at these details to decide if any part of your compensation is taxable. If your settlement does not explicitly state what each part of the money is for, the IRS might consider some of it as taxable income.
Our attorneys at RileyCate, LLC, have over a century of combined experience in representing motor vehicle accident victims throughout Indiana and nationwide. Having obtained more than $15 billion in settlements and verdicts for our clients, we know how the tax side of these settlements work.
We can make sure the agreement is structured correctly before you sign on the dotted line. This analysis of the wording alone can make a significant difference in how much tax you might have to pay on your settlement. Otherwise, there is a risk that you might end up having to pay a significant amount in personal gross income taxes. We can help make sure your settlement is arranged in a way that minimizes your tax liability.
Call us at (317) 588-2866 or contact us online today to schedule your free consultation with us.