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
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.
today to schedule a free initial consultation.