After going through the stress and trauma of a car accident, the insurance claims process, and what is often a lengthy car accident settlement or lawsuit process, the last thing many people think of is taxes. But before you go spending any of your settlement money on much-needed medical expenses, property replacement, or other steps to move on, it’s critical to understand how taxation works for a car accident settlement.
Knowing whether your car accident settlement is taxable and how much of it is taxable can help you avoid issues later. This easy-to-understand guide can help you understand some of the basic information around settlement taxability so you can protect your assets and legal rights. Each situation is different, so when in doubt, always consult with an experienced attorney or accountant.
Taxes on Car Accident Settlements Explained
Like other questions on taxability, the laws and policies surrounding taxation of legal settlements are handled by the Internal Revenue Service (IRS). According to the IRS, whether or not a car accident settlement is taxable largely depends on what the settlement is for.
For example, settlement money intended for medical expenses, pain and suffering, and property damage due to a car accident injury is usually not taxable. However, other settlement compensation, such as lost wages and certain types of emotional distress related to a car accident, are considered taxable.
Are there Taxes on Lawsuits?
Suppose a personal injury lawsuit goes to court and damages are awarded by a judge instead of being settled out of court. In that case, the taxability of these funds will also largely depend on the purpose of the funds. Similarly to a settlement, compensatory damages for medical expenses, property damage, and pain and suffering related to a car accident will generally not be taxable, while lost wages will be.
Additionally, punitive damages, which are awarded to punish a defendant for particularly reckless or malicious actions and deter others from similar behavior, are usually taxable.
If a lawsuit also awards interest for damages, these will usually be considered taxable.
What Is Taxed and What Isn’t
Here is a basic breakdown of what is usually considered to be not taxable in a car accident settlement:
- Compensation for medical expenses directly related to an injury from a car accident
- Compensation for damaged property related to a car accident
- Compensation for pain and suffering related to a car accident injury
- Compensation for emotional distress as long as it is directly related to a car accident injury
The following payments for a car accident settlement are usually considered to be taxable:
- Compensation for lost wages
- Compensation for emotional distress from a car accident that is not explicitly related to an injury
- Any interest awarded as part of a car accident settlement or any compensation that could be considered a financial or capital gain
The taxability of these specific categories can change according to individual circumstances and changes to the tax code. This is why it is vital to have professional guidance when determining if and how much of your specific settlement is taxable.
How to Reduce Your Taxes
The IRS has strict guidelines on what parts of a settlement are taxable and not taxable. This means there is generally no magical and legal way to lower your taxes on a car accident settlement.
The most effective way to protect yourself and pay the correct taxes is to ensure that your car accident settlement funds are clearly broken down according to their specific intention. For example, assume you receive a $25,000 settlement: $15,000 is for medical expenses, $5,000 is for lost wages, $4,000 is for pain and suffering, and $1,000 is for emotional distress unrelated to the injury. You should ask for a document that clearly delineates this that you can take to your accountant or tax preparer.
How a Lawyer Can Help
Whether you are just beginning the car accident settlement process or have recently received a settlement and aren’t sure if it is subject to taxes, it is important to find an experienced and knowledgeable car accident attorney who will stick up for your rights and protect your assets and interests. When reaching a settlement, an attorney can help you understand what the settlement funds are for and how much of it is taxable.
If you have questions about an existing settlement and don’t believe your attorney was clear about the taxability of your compensation, sometimes a second pair of experienced eyes can help.
Contact Clark Law Today for a Free Consultation
If you or someone you love was involved in an accident that may be entitled to a car accident settlement, or have questions about an existing settlement, call our dedicated team at (855) 680-4911 or schedule a free consultation. The longer you wait, the higher the chances that you may lose out on your ability to file for certain types of compensation or on your ability to obtain reliable evidence or advice for your case.
Disclaimer: This blog is for informational purposes only and does not create an attorney/client relationship.