If you have gotten a settlement or judgment after a car accident, you probably want to know if you must pay taxes on that money. The short answer is, no. But this is not a hard and fast rule, and the exact answer depends on the circumstances of the case. Keep in mind that while the guidelines below are generally accurate, only your tax advisor can give you tax advice.
The first thing to know is that car accident claims compensation, settlements and judgments are usually viewed the same way when it comes to taxes. So it does not matter whether the money you are receiving is coming through a judgment or settlement. The tax implications are the same.
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The IRS regulation that deals with settlement and judgment taxation is found at 26 CFR 1. It states that damages that are received because of personal physical injuries or physical sickness are excluded from federal taxation. However, you should know that ‘emotional distress’ is not a physical injury and money received for it can be taxed, UNLESS it is directly related to a physical injury.
For example, if you suffer emotional distress from being in a car accident not tied to a physical injury, that money is taxable. But if you suffer nightmares and sleeplessness because of the pain of a physical injury, that money is usually not taxable as income.
The money that you receive for medical expenses and injuries are known as compensatory damages or general damages. These damages are intended to pay you for medical costs, lost wages, and pain and suffering. Most of that money will not be subject to state or federal taxes.
Money that you receive for vehicle and property damage also is not taxable as income. This is also true for costs of repairs that were paid, as well as reimbursement you might have gotten for a rental car while your car was being repaired.
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When it comes to money that you receive as compensation for lost income, this is generally subject to taxes. The idea is that your original salary or wages would have been taxes if you had been working, so any compensation for your inability to work should be taxed, as well. If your settlement or judgment has compensation for other losses, such as medical costs, you need to pay taxes on the part of the settlement or judgment that is for the lost wages.
Regarding punitive damages, they are rarely part of a car accident judgment or settlement. This type of personal injury damages is usually designed to punish the defendant and to discourage bad behavior in the future. Punitive damages only are awarded in unusual circumstances where the liable driver engaged in particularly reckless behavior. If you do receive punitive damages, that money is almost always taxable.
Your personal injury attorney should be able to give you plenty of information about the taxability of your judgment or settlement. But it is always critical to remember that most personal injury attorneys are not tax law experts. If you have complex questions about the tax implications of your settlement or judgment, you should talk to your tax advisor.