Do You Pay Taxes On Car Accident Settlements?
Whenever someone receives a large sum of money, the subject of taxes often comes up. We are often asked, “Are car accident settlements taxable?”
For the most part, victims do not have to pay income taxes on a settlement or judgment from a car accident. However, there are certain types of damages they might receive that could be subject to tax.
If someone’s negligent driving caused an accident that resulted in serious injuries, the injured party deserves compensation. It is still worth seeking damages, even if taxes might be applied to the cash settlement received.
Reimbursement vs. Other Income
As a general rule of thumb, a reimbursement to offset a victim’s out-of-pocket costs is not taxable, but any additional amounts over and above that could be. The entire purpose of compensating a victim after a car accident is to make them whole. This means restoring them both physically and financially to the condition they were in before the accident.
Harmed parties deserve reimbursement for lost or damaged property, and for any medical expenses to treat their bodily injuries. Their car and its contents will be repaired and replaced. For their personal injuries, compensation will cover not only emergency care, but all ongoing treatment and rehabilitation to help them recover completely, or to the fullest extent possible.
Victims pay these costs out of their own pocket unless and until they can be reimbursed by the at-fault driver or their insurance company. The amount is not taxed because it is a dollar-for-dollar reimbursement backed up by actual bills for car repairs or medical treatment.
While invoices or estimates for actual out-of-pocket expenses can be submitted to an insurance company, claims often include additional compensation as well. These portions of a car accident settlement may or may not be taxable, depending on the exact nature of the settlement.
Recouping Lost Wages
Many car accident claims include a provision for lost wages if recuperating from the accident makes the victim miss work. This could be as little as a single day’s pay, or total projected lost income into the future for someone who is permanently disabled.
This portion of a settlement is replacing the person’s paycheck. As such, it is subject to tax at the same rate their salary would normally be. The amount is then claimed on the individual’s tax return as income.
Are Car Accident Settlements Taxable for Pain and Suffering?
There is a category of compensatory damages known as general damages. General damages represent the non-economic harm the person experiences due to the crash. Known by several different terms, these may be classified as pain and suffering, emotional distress, mental anguish, psychological trauma, etc.
These conditions carry a dollar amount in a car accident claim that can not always be supported by actual payments. Instead, a victim and their attorney will come up with an amount that they feel fairly reflects the hardship.
Trauma-related compensation may or may not be taxable. If a physical injury is clearly the cause of the condition, the settlement would be non-taxable, just like any medical expense. An example would be a victim who loses a limb or becomes paralyzed in an accident and suffers from depression as a result.
In another example, a person might walk away from an accident without any physical injuries, but develop PTSD and a phobia of driving. Without any underlying physical condition, the victim might have trouble proving that the accident was the proximate cause. If the victim’s attorney is still able to make a convincing case and win a settlement, the IRS will likely consider the money taxable.
Taxing Punitive Damages
Punitive damages serve to punish a driver whose behavior showed a flagrant disregard for human life. Awarding punitive damages in a car accident case is extremely rare.
If a portion of a settlement is designated as punitive damages, that amount of money goes beyond offsetting a victim’s actual costs. The IRS considers this income rather than reimbursement. The victim must claim it as such on their tax return. This is taxed just like any other income according to the individual’s tax bracket.
Are Car Accident Settlements Taxable By State?
Most states, including Missouri and Illinois, treat the taxation of car accident settlements the same as the IRS. If the IRS considers a portion as taxable income, for example, punitive damages, so will the state.
State tax returns start with the Federal Adjusted Gross Income that has been calculated on the person’s federal tax return. This means that any settlement amount represented will be automatically added to the state tax return. Aside from taxing the money according to the person’s tax bracket like any other income, there is no additional tax (or exemption) at the state level.
Does it Matter if I Settle Out of Court?
As far as the IRS is concerned, it does not matter how car accident damages are paid. When it comes to taxes, a claim paid by an insurance company without dispute, an out-of-court settlement, or a judgment awarded by the judge or jury in a lawsuit, are all handled the same.
One thing that does make a difference is money in a lump sum versus money paid in installments. A lump sum would be taxable in the year it was received. If the amount is large and taxable, the victim could end up owing a lot in taxes. It is possible to request that a settlement be paid out over several years, spreading out the income and therefore the tax liability.
It is also worth noting that a victim might claim their medical expenses on their tax return if they have not received a settlement by the end of the year. When the settlement is received the following year, they will need to account for this and pay back any refund or credit they received.
Structuring Settlements to Reduce Tax Exposure
It can be difficult for an individual to deal with a car accident claim all by themselves, especially when they are trying to recover from injuries. Experienced personal injury attorneys like Hipskind & McAninch can help file the claim and see it through to a successful resolution.
A seasoned attorney can guide the victim through the process, negotiate with the insurance company, and file a lawsuit if that becomes necessary. They will not only help calculate how much to demand as compensation, but they can also structure the settlement request to minimize the amount of tax liability.
If you or someone you know has been in a car accident, the attorneys of Hipskind & McAninch can review your case and decide the next steps toward compensation.