Getting a settlement following a car accident can feel like getting injured all over again. You might have endured everything from exhausting depositions and settlement conferences to an insurance company intent on dragging out the process as long as possible. Finally being compensated for pain and suffering probably feels like reaching the finish line after a marathon. Giving some of that money to the government might be the last thing on your mind. So what do you need to know about taxes and car accident settlements?
When people receive settlements or judgments following a car accident, it is usually limited to “compensatory damages” and “general damages.” For example, you may have been hospitalized following a car accident. The ambulance ride, treatment for your injuries, your stay –– it can easily add up to thousands of dollars. Once you are released, you may have required physical therapy.
All of these expenses can be included in your auto accident settlement. The good news is compensation for medical expenses generally isn’t taxable. As the Internal Revenue Service explains, “If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income.”
The exception is clearly stated. It might have taken some time before you received the settlement and you took a deduction. So, if you deducted medical expenses in a prior year and it provided a tax benefit, you should report it as other income. If you receive an award for emotional distress, then it is taxable as well.
Vehicle and Property Damage
If your vehicle was damaged or destroyed in the accident, you may have received money to repair or replace it. You might have needed to rent a vehicle. When you receive a settlement that covers this, it isn’t taxable either.
Following the accident, you may have had to take time off from work because of your injuries. Or you might have been unable to run your own business. This often happens even when you don’t require hospitalization –– as is the case with soft tissue damage or whiplash. If a portion of your settlement is connected to lost wages, then this amount is taxable. After all, if you were working you would likely owe taxes on your income.
Far more common in class action lawsuits against large companies, punitive damages are only accessed in auto accident claims where the other driver is guilty of gross negligence. That’s because the amount is intended to punish the driver and deter other drivers from similar actions. If you did receive punitive damages as part of your settlement, this would be taxable.
If you received a large settlement, you may decide to put some of the proceeds into a bank or investment account. If the principal grows whether through interest, the growth of a mutual fund, or other investments, you will owe taxes on the amount of increase –– not the initial sum.
Tax laws are tricky. Attorneys who specialize in auto accident settlements recommend that their clients consult with a licensed tax professional. However, a skilled car accident lawyer will work hard to make sure your settlement is as tax-friendly as possible. If you receive a large settlement, they might recommend a structured settlement.
Generally, the insurance company will purchase an annuity in your name –– the payments you receive from this will be nontaxable. Properly designed structured settlements can trim over one-third of your tax bill. Whether you are seeking a settlement from a car accident or are worried about taxes, consulting with a skilled attorney should be your first step.
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