Before you decide how to distribute your settlement funds, you must determine whether your car accident insurance settlement is taxable. It’s one more complicated step in resolving your injury claim, but it prevents later difficulties. Whatever you have planned for the future, you can feel confident that you won’t have any unforeseen tax problems.
For the most part, car accident insurance settlements are not taxable. However, you may owe income tax on specific portions of your settlement. Your personal injury attorney can review basic tax issues, but you should also check with your tax professional for further guidance.
The Internal Revenue Code Defines Taxable Settlement Income
The U.S. Federal code eCFR §1.104-1(c) establishes settlement taxability guidelines. The provisions explain that “in general” damages for “personal physical injuries or physical sickness” are not taxable. As most people never get around to reading federal statutes, the IRS provides supplemental information on their website under the topic, Court Awards and Damages.
They also provide this information in a simple, user-friendly bulletin format. Publication 4345, Settlement Taxation explains the exceptions to the non-taxable rule. It also provides brief explanations as to the rationale behind the guidelines.
Some Portions of Car Accident Insurance Settlements Are Taxable
The IRS term, “personal physical injuries or physical sickness,” is specific and deliberate in describing non-taxable settlement income. Based on this definition, settlement income is usually non-taxable when it’s incurred due to a physical injury or physical sickness. Publication 4345 describes types of settlements that don’t qualify for non-taxable status.
IRS taxable -vs- non-taxable designations seem more logical when you realize that they apply to car accidents and other types of injury claims as well. These include worker’s compensation claims, and nonphysical personal injury claims such as discrimination, wrongful termination, defamation, and slander.
Although car accident injury settlements are non-taxable for the most part, making that determination is sometimes complicated. In many cases, a settlement can include taxable and non-taxable proceeds. To recognize the differences, you must get to know these IRS guidelines.
A Settlement for Emotional Distress or Mental Anguish Can be Taxable or Non-Taxable
When physical injuries or sicknesses cause distress or anguish, the settlement is non-taxable. A settlement for emotional and mental injuries is taxable if it’s not associated with a physical injury or sickness. For example, if a person sustains only emotional trauma from an accident (PTSD, mood swings, chronic depression), the IRS considers the settlement taxable income.
Punitive or Exemplary Damage Awards Are Taxable
In Nevada, juries may award punitive and exemplary damages to an injured plaintiff. This portion of a plaintiff’s claim is taxable because it doesn’t reimburse the plaintiff for physical injuries. Punitive and exemplary damages are a punishment for a defendant’s acts of fraud, malice, or oppression.
You May Owe a Share of Medical Bills Previously Deducted on Prior-Year Tax Returns
If you had uncovered accident-related medical bills, you may have qualified for a medical tax deduction in previous years. If the liability insurance company includes these bills in your car accident settlement, they become taxable income. If you deducted these bills over multiple years, the IRS allows you to file them as prorated income when you receive reimbursement from your settlement.
The Wage Settlement Portion of an Auto Injury Settlement Is Non-Taxable
Lost wages related to a car accident injury settlement are not taxable, although the rule is different for other types of settlements. If you receive back wages as part of wrongful termination, discrimination, or other non-physical injury settlement, they are taxable. When you receive a taxable income settlement based on wages, you may also owe Social Security and Medicare taxes.
Portions of Your Lost Business Profits Settlement Are Taxable
A car accident-related injury can temporarily put your business or self-employed gig-work on hold. The costs you pay someone else to keep your business running are a valid part of your lost profit claim. If the liability insurer reimburses your lost profits and business continuation expenses, the IRS considers the business continuation expenses taxable income.
Any Interest Your Settlement Earns Is Taxable Income
If you’re like many people, you will deposit your settlement funds in an account where you’ll earn maximum interest. That’s a reasonable idea, but you should be aware of how your earned interest affects your tax status. Even if your settlement is non-taxable, any interest or income you earn is taxable.
A Taxable Settlement May Change Your Health Insurance Tax Credits
An increase in your taxable income may create an additional tax issue if you purchase health insurance through Nevada Health Link or another federally funded marketplace. Your increased income could alter your advance premium tax credits since they are based on your income. When you receive a car accident insurance settlement, the IRS recommends that you notify your health insurance marketplace to avoid large, future rate adjustments.
Contact a Nevada Personal Injury Attorney Today
To schedule a legal consultation, please visit our contact page and leave a detailed message. During your complimentary consultation, you have an opportunity to discuss your accident with a legal professional. We listen to your version, discuss your legal options, and determine if we can help you.