Austin Personal Injury Blog

Are Car Accident Settlements Taxable?

Posted By The Stewart Law Firm, PLLC || 31-Jul-2017

After a car accident, the financial stress of medical bills and lost wages can become overwhelming. Pursing compensation from those responsible may provide financial relief in the form of a settlement. However, is that settlement taxable? The short answer is no, with some exceptions. Most car accident settlements are tax deductible, but there are certain kinds that are taxable. It depends on the reason for the specific payments and on the structure of the settlement. The Internal Revenue Service (IRS) lays out ground rules for determining which car accident settlements are taxable.

Here’s What You Need to Know About Taxes and Car Accident Settlements:

1. Tax Deductible Settlements

Generally, compensation for medical bills, as well as pain and suffering, is tax deductible. Many car accident settlements are comprised of general and compensatory damages, which provide financial relief for injuries, illnesses, and medical expenses resulting from an accident. These are not taxable. However, under IRS regulations, you are only allowed to deduct medical costs that are greater than 10% of your adjusted gross income, or 7.5% if you are age 65 or older. Furthermore, if you deducted medical expenses in a previous tax year, you must pay taxes on the settlement award that covered the medical expense of the previous tax year.

In addition, a financial settlement for car and vehicle damage caused by an accident is tax deductible. This also applies to expenses for rental cars you use while your vehicle is out of commission. Furthermore, reimbursement for car repairs and other vehicle expenses that directly result from an accident is not taxable.

2. Taxable Settlements

While medical expenses, pain and suffering, and vehicle damage expenses are not taxable, there are some types of financial settlements that are. It is important to pay attention to the structure of your accident settlement to understand what you will need to pay taxes on. In general there are 4 categories of car accident settlements that are taxable.

You will have to pay taxes on compensation for:

  • Lost wages/profits
  • Punitive damages
  • Emotional distress
  • Interest on any award

Compensation for lost wages is subject to the income tax. Since your original income is subject to the income tax, a financial settlement to replace your income is also taxable. Furthermore, punitive damages are taxable. These damages are meant to punish a wrongdoer, and are only awarded in extreme cases where the driver who caused the accident acted recklessly or with little regard to human life.

Furthermore, emotional distress is generally taxable under IRS regulations. While pain and suffering directly results from an accident, emotional distress often causes long-term disorders that may not always directly link to injuries resulting from the accident. For example, depression resulting from an accident involving the loss of a loved one counts as pain and suffering, and is not taxable. However, a fear of driving that occurs after an accident counts as emotional distress and is taxable.

How to Seek the Greatest Financial Settlement while Avoiding Taxable Awards

There are generally 2 ways to avoid taxable financial awards and help you keep more money from your settlement. The first way is to make your financial award into a structured settlement. This will spread out your compensation over a period of years, instead of providing you with a lump sum that results in higher taxes. The second way is to try to classify your financial settlement to include the most tax deductible awards while avoiding the taxable awards.

Compassionate Legal Assistance for Car Accident Victims

The Stewart Law Firm, PLLC provides diligent representation to victims of car accidents. We can analyze your situation and work hard to find solutions that meet your legal needs. If you have been injured, it is important to seek legal representation right away to pursue the compensation you deserve. Our Austin car accident lawyer can walk you through the process.

Contact us today to schedule a free initial consultation.

Categories: Car Accidents
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