You’ve been in an auto accident and weren’t considered the at-fault driver. You received a settlement. When tax time arrives, will you have to pay taxes on your settlement? Probably not. Generally, car accident settlements are not taxable. But there are exceptions you need to consider.
Rule of Thumb: Is it Financial Gain?
The rule of thumb test to know what parts of a settlement are or aren’t taxable is this: Can the money received be considered financial gain?
- If it is not financial gain it is tax exempt
- If it is financial gain it IS taxable
What is NOT Taxable?
- Medical care
- Pain and suffering (if due to physical injuries)
- Property damage
What IS Taxable?
- Lost wages
- Emotional distress
- Punitive damages (most)
- Interest earned on settlement
Reparation for Medical Care – Not Taxable
Injuries due to an auto accident can result in thousands of dollars in out-of-pocket medical care bills. For example, medical care might include the following:
- Inpatient and outpatient hospital care
- Prescription drugs and over-the-counter drugs
- Doctor’s office visits
- Physical rehabilitation
- Assistive devices such as a wheelchair or crutches
Medical care damages in a settlement are based what you pay for out-of-pocket and anticipated future medical treatment.
Compensation for Pain and Suffering (due to physical injuries) – Not Taxable
In order to receive compensation for pain and suffering, they must be related to physical injuries. By themselves, pain and suffering compensation is taxable. The amount received is influenced by the severity of the injuries.
Compensation for Emotional Distress – Taxable
Emotional distress compensation is taxable if it is not related to injuries from the accident. Typically, emotional distress includes emotions such as:
If the distress results from the emotional trauma of the accident, not injury, monies received in settlement are taxable.
Loss of Income Compensation – Taxable
When your injuries keep you from earning an income, the settlement takes into account future earnings as well. Because income is generally taxable, settlement payments are also, and the amount should be included in gross income when it’s tax time.
Payments Received for Property Damage – Not Taxable
Compensation for out-of-pocket costs related to property damage can be used to reimburse repairs or even renting a car while your vehicle is out of commission. These funds are not taxable.
Interest Earned on a Settlement – Taxable
If the settlement payment is put into an interest-earning account, the individual will need to include the amount on a tax return.
Funds for Punitive Damages – Taxable
Punitive damages might be assigned to the at-fault driver if the person purposefully disregards the safety of others and causes injury. For example, the car is driven into a crowd or at the other driver in an effort to injure him or her. Punitive damages must be reported on the victim’s tax return.
If you are caught up in a complicated settlement such as these, you may need to consult with a tax specialist and-or attorney.