As a victim who is trying to settle his/her accident claim, you are likely wondering whether you’ll need to pay the auto accident settlement tax on the amount that you’ll recover for your expenses. The short answer is no. However; some exceptions are tied to the circumstances and nature of your settlement or judgment. So it’s safe to say that whether or not your compensation will be taxed depends entirely on the awards you receive in the settlement.
In general, judgment and settlement proceeds from a personal injury case are not subject to federal or state income tax according to the tax code. This is because a majority of these suits involve physical injuries which the Internal Revenue Service (IRS) treats as non-taxable. So, simply put, the IRS (or any other tax authority) won’t tax you on judgment compensation or settlement for your personal injury case.
Taxable parts of your claim
The settlement you get for lost wages will be subject to tax because if you weren’t involved in an accident, your wages would still be taxed. Based on the extent of your injuries, you may recover settlements for future wage loss, in which case, you will need to pay taxes on that part of your settlement too.
Since it might take time for an insurer or judge to issue or order settlement, the amount may accrue some interest. If it does, you will need to pay taxes on the interest.
This settlement is meant to punish the at-fault driver for their negligence that caused your injuries and to prevent others from behaving similarly. And since punitive damages aren’t designed to compensate you for your losses and injuries, they’re often taxed.
Non-taxable part of your claim
All personal injury reimbursements include compensation for medical costs. Usually, this money is non-taxable. You may only need to pay tax if you deducted those same medical costs on your tax return. According to the IRS, medical expenses are costs incurred to diagnose, treat, cure, prevent, or mitigate an infection or disease or for the goal of affected any function or structure of the body. So, you only pay taxes once you have removed the expense. A section of your general medical cost is taxable, but only when you are not compensated for them. Simply put, if you exclude those costs on your tax return as expenses, then receive compensation for the same cost from the reimbursement, they seize to be expenses.
It could be that you were forced to pay for the medical expenses out of your pocket while your claim was ongoing. In that case, when you get the full settlement amount, you should think about whether you have taken a tax deduction for those medical costs. If yes, put aside at least one-third of the entire amount of those costs from your lump sum settlement as you will probably have to pay the total income tax.
If it sounds confusing, or you are unsure about how much you’ll need to pay as tax, feel free to talk to a personal injury lawyer near you.