Insurers award insurance settlements to compensate an injured party for her damages and losses. However, sometimes these insurance settlements end up costing more than a victim had originally thought when tax season comes around. Whether car insurance settlements are taxable depends on the type of settlement and what damages the insurer awarded.
What damages are taxable?
Lost wages
The reasoning behind the government taxing the lost wage portion of your settlement is very clear. The IRS taxes your regular wages and earnings and because payments made in a settlement for lost wages replace what you would normally have earned, the portion of the settlement designed to replace lost wages is taxable.
What damages are not taxable?
Property damage
Property damage settlements only compensate accident victims for the damage done to their property and, as such, are not taxable. As long as the payment does not result in a windfall to the owner but instead puts her back to where she was prior to the accident, it should not result in a tax implication.
Medical expenses
Much like the payments for property damage, these payments help the injured party return to the position she would have been in but for the accident. Therefore, the costs of medical expenses are not generally taxable unless the injured party has already received a tax benefit from them. In other words, if you take a deduction for medical expenses, and then recover those same costs in a settlement, you would need to pay taxes on the settlement.
Are there any damages that can be both taxable and non-taxable?
Yes. While emotional distress or “pain and suffering” are not specifically non-taxable, if they are attributable to the physical conditions sustained, they fall within that part of the injury, as per 26 U.S. Code § 104(a)(2). However, if the insurer awards emotional damages separate from the physical injuries, they will be taxable.
Are punitive damages, if awarded, taxable?
Yes. Punitive damages, which a judge or jury awards in select cases to punish the at-fault party for wrongdoing or malicious behavior, are taxable as income according to 26 U.S. Code § 104(a)(2).
Can someone help me make sense of all this?
As shown above, trying to figure out whether the IRS will tax you on your car accident settlement can be very confusing. Be sure to speak with car accident attorney David Bressman to clear up the uncertainty. Contact Bressman Law today at 877-538-1116.