If you have a personal injury claim, you are likely confused regarding the tax liability your settlement may incur. Some auto accident settlement elements are taxable, while others may become taxable based on specific circumstances. However, determining whether certain portions are taxable or not can be complicated. For this reason, it is essential to work with an auto accident attorney to help you.
At Pacific West Injury Law, we have an experienced legal team that can help you understand which elements of your auto accident settlements are taxable. That said, here is what you need to know about car accident settlements and taxes.
How Taxes Work on Auto Accident Settlements
Generally, some auto accident settlements are taxable, while benefits that compensate for your medical expenses, property damages, and pain and suffering are not taxable. However, your auto accident insurance settlement is taxable when you receive compensation for emotional distress or lost income. Essentially, specific auto accident settlement elements may be taxable based on how you structure and label your settlement.
If you receive a settlement and consider reducing taxes, working with a professional legal team can help. An attorney understands various aspects of settlements, including related tax laws, letting you save time and stress when filing your taxes. This ranges from determining what elements of your auto accident settlement are subject to tax, including those which are tax-free.
Auto Accident Settlements that Are Usually Taxed
The judge may award multiple benefits when determining your auto accident insurance settlement based on the evidence provided and other factors. With that, here are elements of car accident settlements that are taxed:
- Lost wages
- Lost long-term income
- Emotional distress
- Punitive damages
- Interests
Auto Accident Settlements that Are Not Usually Taxed
Regardless of how much or damage you receive, certain aspects of your auto accident insurance settlement are not taxed. These include:
- Doctor care
- Medical devices
- Prescriptions
- Pain and suffering benefits
- Physical therapy
- Surgeries and diagnostic procedures
- Emergency medical bills
- Property damage
- Laboratory work
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Are Punitive Damages Subject to Income Tax?
Internal Revenue Service (IRS) publication 4345 states that punitive damages for auto accident settlements are subject to income tax. Besides, these damages must be reported as income for victims of car accidents who receive punitive damages. Therefore, under the US federal tax law, punitive damages should be reported as other income and reported on a 1040 tax form.
Are Property Damage Settlements Taxable?
If you receive compensation for property damage, you do not have to pay taxes on the damage amount. This is because you are receiving benefits to recover the reduced value of your property, unlike an amount considered as income.
Consequently, being taxed on property damage means that you will not receive the total amount to cover your losses caused by a car accident. In addition, tax laws recognize that it is unnecessary to tax a victim for a property damage settlement.
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Can I Reduce My Taxes Related to an Auto Accident Settlement?
Structuring your settlement is crucial to avoid triggering tax liability, letting you reduce auto accident settlement taxes. For instance, pursuing compensation for medical bills which are not taxable, allows you to receive a tax-free settlement. In addition, a car accident lawyer can help classify the payment for medical purposes if possible, exempting taxes on your auto accident settlement.
Also, you can label a settlement as compensation for pain and suffering, making it exempted from taxes as pain and suffering stemmed from physical injuries. Even when you have some tax liability, structuring payments over several years lets you reduce auto accident settlement taxes. It ensures your total taxable income is distributed over the years rather than being too high in one year.
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The IRS Rule on Taxability of Settlements
The Internal Revenue Service (IRS) regulation addresses the issue of whether auto accident insurance settlements are taxable or not under Article 26 CFR §1.104-1(c). The act states that benefits from a personal physical injury or sickness are excluded from gross income besides punitive damages. While emotional distress cannot be considered physical sickness or injury, the settlement received is taxable even when the amount awarded is paid for medical care.
Nonetheless, other federal and state income regulations and laws may apply in your auto accident settlement. Therefore, working with a skilled car accident lawyer can help you understand how your compensation might be affected by tax laws and regulations.
How an Attorney Can Help You Figure Out Auto Accident Settlement Taxes
Attorneys have a better understanding of how settlement taxes and tax laws work, especially if you need to reduce car accident insurance settlement taxes. For example, if you receive $100,000 in settlement for lost wages and lost future income, you attract the 24% highest tax bracket. This means that you will be paying an income tax rate of 24% on every portion of the income.
But if you choose to structure the payments over five years and receive $20,000 payments annually, your highest tax bracket would be 12%. An attorney can help you reduce significant taxes you will likely pay without properly structuring and labeling your settlement. Other ways an attorney can help include:
- Explaining the nuisance of tax law
- Determining if your car accident insurance settlement is taxable
- Reviewing every aspect of your payment and preventing you from making irrational decisions
- Ensuring you remain on good terms with the IRS
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