During the first couple of months of every new year, we get a lot of questions about taxes. But no, we aren’t tax lawyers. Instead, the questions revolve around whether or not the car accident settlements we’ve helped our clients receive are taxable. And it’s a fair question; taxes can get complicated, especially when money is coming to you from a source it may never have before. It’s helpful to understand what you do and don’t need to worry about it so you can finally put your accident behind you.
Q: Is car accident insurance settlement money considered income?
A: No, the settlement money (also called “proceeds”) you receive after a car accident is not considered income, meaning it is not legally taxed in the same manner as income you would receive from an employer or other forms of reportable and taxable income.
Q: Are car accident insurance settlements taxed?
A: In most scenarios and under most circumstances, the money you receive from a car accident settlement is not directly taxable by the Internal Revenue Service. This most often includes proceeds for medical expenses, lost wages, property damage, or other pain and suffering. And this is again because that money is not considered income by the U.S. government.
Q: Are there exceptions to not paying taxes on car accident settlements?
A: According to the IRS, when it comes to physical injuries suffered after a car accident, there is one possible exception that could result in a scenario that would require you to pay some money back to the government. If you used any portion of the settlement meant to cover your medical expenses to pay any related medical expenses that you already deducted specifically as a tax benefit during the previous year, you must then allocate the necessary part of those proceeds back to your current tax payments. You will be required to calculate the exact relevant amount, and the benefit can be reported as “Other Income” on your Form 1040. But if using your proceeds in that way did not provide any sort of tax benefit to you, then you do not need to worry about paying any part of it back.
Q: What if part of my settlement replaces my lost wages while I’m unable to work? Isn’t that considered “income”?
A: According to the IRS’s rule, not when it comes to a car accident settlement specifically. The IRS has stated that a settlement award that is meant to cover lost wages after a car accident prevents you from working is not considered regular income, and so is not taxable as income.
However, if you’re specifically involved in some kind of workers’ compensation lawsuit (rather than a car accident-related lawsuit), and your settlement involves coverage for lost wages with that employer, the taxable income rules apply differently. It’s best to check with a certified workers’ compensation or tax attorney if you believe this scenario might apply to you.
Q: What are punitive damages, and are they taxable?
A: Yes, punitive damages are taxable. Punitive damages are “additional” damages in a case that are assessed and awarded in an effort to further punish the defendant for particularly outrageous conduct or behavior. They are awarded with the intention of making an example of the defendant in order to deter others from engaging in similar conduct. Not every car accident lawsuit results in punitive damages, and as a uniquely specialized element of the overall settlement, those damages are taxable as income—because they are considered “additional” proceeds.
Q: What if I decide to invest my awarded settlement money? Is that taxable?
A: While the invested money itself is not taxable, any interest earned on that invested money is taxable as income. If you use any portion of the settlement you received to make investments of any kind, and you gain any interest or returns on those investments, that interest is still taxable the same way any other type of invested money would be taxable.