In Oklahoma, as in the rest of the United States, the tax treatment of car accident settlements is governed by federal tax law, with certain state-specific considerations.
Tax Treatment of Car Accident Settlements
The Internal Revenue Code (IRC) guides the taxability of income, including settlements from personal injury cases. Under Section 61 of the IRC, all income is generally considered taxable unless another section specifically excludes it. Fortunately for many claimants, Section 104(a)(2) of the IRC excludes damages received from gross income for personal physical injuries or physical sickness. This means that compensatory damages, which are intended to make the injured party whole, are typically not taxed. This includes:
- Compensation for bodily injuries
- Lost wages due to the injury
- Medical expenses related to the injury
The Internal Revenue Code Section 104(a)(2) clearly states that personal injury settlements for physical injuries, emotional distress, and mental anguish resulting from those injuries are not taxable. Oklahoma law reinforces this federal statute, instructing juries via 12 O.S. §12-577.4 that awards for personal injury or wrongful death should not be adjusted for tax considerations.
However, there are notable exceptions to this rule that claimants should be aware of:
Exceptions to the Non-Taxable Rule
Previously Deducted Medical Expenses: If you’ve deducted medical expenses related to your injury on a previous tax return, the portion of your settlement compensating you for those expenses may be taxable.
Emotional Distress or Mental Anguish Without Physical Injury: If you receive compensation for emotional distress or mental anguish that is not directly related to a physical injury or sickness, that compensation may be taxable.
Punitive Damages: These are awarded not for compensation but to punish the defendant for egregious behavior. Punitive damages are taxable and should be reported as “Other Income” on Form 1040.
Impact on SSI Benefits
Receiving a car accident settlement could also affect your eligibility for Supplemental Security Income (SSI) benefits. The Social Security Administration considers various forms of income and resources when determining eligibility. A settlement that increases your assets or income above certain thresholds could reduce or eliminate your SSI benefits. Reporting any such financial changes is imperative to maintain compliance with the program’s requirements.
Property Damage Settlements
In the unusual event that you receive a property settlement that exceeds the adjusted basis of the property (what you paid for it), the excess is considered taxable income. This situation has become more common with the fluctuations in the used car market post-COVID-19.
Settlement vs. Verdict
The tax implications are generally the same whether you receive a settlement or a court awards a verdict. The IRS does not distinguish between the two when it comes to taxation.
Does the compensation make a difference for tax purposes if it is a settlement or verdict?
No, the IRS treats personal injury settlements and verdicts the same.
What Types of Compensation for Physical Injuries or Sickness Are Generally Not Taxable?
Compensation for personal physical injury or sickness, such as recovery for medical expenses, lost income, pain and suffering, and emotional distress, are generally not taxable. However, there are exceptions for previously deducted medical expenses and damages not stemming from physical injuries.
When Are Damages for Emotional Distress and Mental Anguish Tax-Free?
According to IRS guidelines, damages for emotional distress and mental anguish are tax-free if they stem from physical injuries. However, if the emotional trauma compensation is unrelated to a specific injury, it may be subject to taxation.
Are Punitive Damages Received on Top of Compensatory Damages Taxable?
Punitive damages received on top of compensatory damages are taxable. Distinguishing between compensatory and punitive damages in a settlement is essential. Discussing tax implications with a lawyer is advisable to ensure proper tax treatment.
Are Non-Economic Losses, Such as Pain and Suffering or Emotional Distress, Taxable in a Car Accident Settlement?
Non-economic losses, such as pain and suffering, are generally not taxable in personal injury settlements.