Are Car Accident Settlements Taxable?
What's In This Article
Car crashes are uniquely stressful. When a person is struck by a driver who was texting while driving, or by a motorist who runs a red light, their entire world can be thrown for a loop. Victims are rushed to the emergency room with their life turned upside. Even after they check out of the hospital, their minds are often swimming with questions about their health, their legal rights and their insurance policy. The last thing on the minds of most accident victims are taxes — though perhaps they should be. Tax confusion can add a layer of uncertainty to what is normally a straightforward accident settlement.
When a victim is awarded compensation by a judge or jury after a wreck, it is generally not taxed. Neither is the claim money paid out by the insurance company traditionally taxable. Blanket statements about taxes, though, never paint the full picture. While car accident settlements are not usually taxed, portions of the compensation may indeed be taxable. When money is on the line, though, it is important to keep Uncle Sam and his purse strings in mind.
Exemptions for Lost Income and Punitive Damages
While income taxes are not usually owed after settling a car accident case, there are some exceptions to the rule. It all depends on how the settlement is structured. Lump sum amounts are not taxed, but if money is awarded specifically to make up for lost wages, taxes will be owed. Wages are taxable, therefore lost wage settlements are also taxable. Because the settlement is replacing taxable income, the government will expect the usual taxes to be taken out accordingly. Social security and Medicare payments will also need paid out from lost income settlements.
When a small business owner loses an opportunity because of an accident, they can be compensated for this financial loss via a settlement. Compensation for future loss of income or business can also be included. They will be required to pay taxes on that money, though.
In some states, punitive damages are taxable. Awarded to accident victims involved in wrecks caused by especially reckless drivers, punitive damages serve as additional punishment for the at-fault driver. The U.S. tax code requires those who receive punitive damages to pay taxes on the settlement. In the eyes of the IRS, punitive damages are income.
Pain and Suffering Taxes
When a car accident victim is awarded compensation for their pain and suffering, the money is generally non-taxable. If that pain and suffering is classified as emotional rather than physical, though, victims will owe taxes. For example, if a person walked away from an accident with no physical injuries, but experienced post-traumatic stress disorder in the wake of the wreck, they are required to pay taxes on any compensation they receive for their emotional trauma.
On the other hand, if a person injures their spinal cord in an accident and becomes paralyzed, they may develop depression because of their injury. In this scenario, the damages awarded for emotional distress is not taxable because it stems from physical injury. The line between emotional and physical pain can be blurred, so victims should speak to their attorney and accountant about taxes on such compensation.
Taxes become all the more confusing when a car accident settlement lands a person in a new tax bracket. Settlements can be hefty and sometimes include years of lost wages that can double or triple a person’s income for the year. While normally this would be worth celebrating, the realization that more taxes will likely be owed can cast a long shadow. On top of income tax, a person awarded compensation for lost wages will also owe payments for Social Security and Medicare.
After factoring in lawyer fees, many find themselves walking away with less than half of what was awarded in the settlement. While itemizing deductions can help soften the financial blow, the overall effect can be frustrating. Those concerned about how tax brackets could impact their bottom line should speak with their attorney and their accountant for guidance.
Get Help Today
State laws surrounding car accident claims and settlements can vary dramatically. Tax law, too, can differ based on where a person lives. For many accident victims, the uncertainty can feel overwhelming. While it is tempting to wash one’s hands of the confusion and worry about it come tax time, getting answers to the big questions can provide a person real relief.
Thankfully, Lawsuit Info Center can help answer those questions. Not only does LIC offer one of the largest resource libraries on the web, we can also connect accident victims with local attorneys who specialize in car accident law. Call 877-810-4067 for a free, no-risk, confidential consultation today.