Car Accident Settlements are Generally Not TaxableUnder Section 61 of the Internal Revenue Code, all income is generally considered taxable unless excluded by another Code section. Damages received for personal physical injuries or physical sickness are excluded from gross income under I.R.C. 104(a)(2). This means compensatory damages for bodily injuries, including lost wages, are generally not taxed.According to IRC 104(a)(2), personal injury settlements for physical injuries, emotional distress, and mental anguish are not taxable. Oklahoma Statutes even require juries to hear a similar instruction before deciding on a verdict, 12 O.S. §12-577.4: “No part of an award for damages for personal injury or wrongful death is subject to federal or state income tax. Any amount that the jury determines to be proper compensation for personal injury or wrongful death should not be increased or decreased by any consideration for income taxes.”BUT! There are exceptions, so read the settlement release thoroughly before signing anything.
Exception: Previously Deducted Medical ExpensesWhile compensation for medical expenses is typically tax-free, there is an exception if you have previously deducted these expenses on your taxes. In such cases, the portion of your settlement representing a recovery for previously deducted medical expenses may be taxable. You may have to include this portion of the settlement as taxable income on your tax returns.
Exception: Emotional Distress Compensation if No Physical InjuryEmotional distress compensation for physical injuries is generally exempt from taxation. However, to qualify for tax exemption, emotional distress compensation must be directly related to the physical injuries or sickness from the car accident claim. Damages received for emotional distress without a bodily injury or sickness are generally includable in gross income.
Exception: Taxability of Punitive DamagesPunitive damages received in a personal injury settlement are subject to taxation. Unlike compensatory damages, which aim to compensate the victim for their losses, punitive damages are intended to punish the defendant for their wrongdoing. As such, they are treated as taxable income by the IRS. On your tax form 1040, you should put this under “Other Income.”If your insurance claim includes punitive damages, you will need the settlement (or verdict) to itemize the compensation for compensatory and punitive damages.
Will Receiving a Car Accident Settlement Affect My Eligibility for SSI Benefits?
Receiving a car accident settlement may impact your eligibility for SSI benefits. The Social Security Administration (SSA) considers any type of income or resources when determining SSI eligibility. If your settlement amount pushes your total assets or income above the allowable limits, it could affect the amount of SSI benefits you receive, or even make you ineligible. It is crucial to report any changes in your financial circumstances to the SSA to ensure you remain compliant with eligibility requirements.
Exception: Property Claim for More Than You Purchased it ForThis was rare for car accident cases before things got weird with the used car market after COVID-19. Property settlements exceeding your “adjusted basis in the property” count as income and are taxable. For example, if you bought a used truck for $12k in 2019, and in 2021, a negligent driver hits you and totals your truck. The fair market value of your truck could be worth considerably more than what you purchased it for, so the excess would be treated (and taxed) as income.Exception: Interest on the VerdictIf the insurance company delays paying you your verdict in a timely matter, your attorney can file a motion for interest on the verdict. This additional interest is taxable.
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.