Is a Car Accident Settlement Taxable Income?

One of the many questions people have about the car accident settlement process is, “Is a car accident settlement taxable income?” Generally, the answer is “no.” However, the Internal Revenue Service (IRS) makes certain exceptions, so anyone claiming a settlement following a car accident should consult a tax advisor or accountant[1].

Typically, personal injury settlements cover costs associated with the accident, like medical bills, out-of-pocket expenses, and property damage. Some settlements may also provide compensation for trauma and suffering. But regardless of what your settlement covers, it’s important to understand the details of your settlement and how it relates to your finances come tax time.

Types of Non-Taxable Compensation in Car Accident Settlements

Your car accident settlement can contain multiple accounts. When considering your settlement for tax purposes, the most common taxable elements include punitive damages and payment for loss of income. Below is a list of collision-related costs that may be non-taxable aspects of car accident settlements.

Medical Care and Treatment

Following a car accident, the accident victim may have to undergo a medical procedure, seek medical treatment, or endure painful rehabilitation. All of these things are costly. If the accident victim receives a monetary settlement, any portion of the settlement intended to cover direct medical expenses would not be taxable[2].

Examples of medical care that is not taxed include:

  • Ambulance rides
  • Prescription medication
  • Surgery
  • OTC medication
  • Assistive devices
  • Physical therapy
  • Doctors’ visits
  • Psychiatrist visits
  • Other medical bills

While these services and expenses are not taxable, punitive damages – awarded to penalize an at-fault driver – are taxable[3]. However, due to the legal and insurance system around these types of accident claims, decisions on a final award amount can take some time. Fortunately, resources like pre-settlement funding can help cover your day-to-day expenses while waiting on a final judgment.

Mental Distress from Physical Injuries or Illness

More serious car accidents may cause victims severe mental or emotional trauma. In these cases, juries may award settlement compensation if they see fit.

Officially, the law states that emotional distress alone is not considered a physical injury or sickness[1]. However, if the emotional distress results from injury or sickness caused by the accident, the court may award the victim financial compensation. In this scenario, the damages awarded would be non-taxable.

Examples of non-taxable compensation (as long as the above conditions apply) could include treatment for the following[1]:

  • Depression
  • Stress
  • Anxiety
  • PTSD

If the court ruled that these listed conditions were simply a result of emotional trauma from the accident and caused no physical ailments, then the compensation would count as gross income and fall under auto accident settlement taxable income.

Vehicle Repairs and Rentals

When most people ask if a car accident settlement income is taxable, they’re thinking primarily of the costs associated with getting back on the road. The good news is the vast majority of compensation related to vehicle repairs and rentals is not taxable.

Examples of non-taxable compensation relating to vehicle damage include[2]:

  • The cost of rental cars required while your original vehicle was in repairs
  • Body shop repairs
  • Car mechanic repairs
  • Like-for-like replacement of a written-off vehicle

The law ensures that compensation makes an accident victim whole, so the above payments are not taxed.

Using broadside collision funding to repair damaged bodywork or replace an unsafe vehicle is not taxable. However, using funding to upgrade a vehicle or conduct repairs unrelated to the accident is taxable[3].

If you’re arranging pre-settlement funding for a rear-end accident, talk to an accountant to plan your finances so you aren’t taken by surprise during tax season.

Types of Taxable Compensation in Car Accident Settlements

According to the IRS, here are the elements of auto accident settlements that are considered taxable:

Punitive Damages

An accident victim may receive punitive damages if the court determines the at-fault driver behaved recklessly. This kind of car accident settlement income is taxable[6], and courts only award punitive damages in limited circumstances where fault is clear and the victim suffered significant damages.

Punitive damages could cover loss of income, loss of consortium, and emotional distress. Like most car accident settlements, the timeline for receiving compensation for punitive damages is uncertain. Fortunately, victims can rely on resources like pre-settlement funding while waiting for a ruling. Traditionally, the funds received through pre-settlement funding have no restrictions on how they can be spent, so they can be a saving grace and help families bridge the gap while waiting for punitive compensation.

From an accounting perspective, punitive damages are generally not excluded from taxation. They would be treated as part of a person’s gross income[7].

Lost Wages

Accident victims may receive compensation for working wages lost while recovering from injuries. This compensation is taxable[4] and, like punitive damages, is treated as gross income.

Compensation for lost wages is important. This money helps a person maintain their quality of life through tough times. Since the money is replacing income they would earn at work, the IRS views it the same way.

Some accident victims may pay a higher tax rate depending on the amount of compensation awarded and when payments come through. Speak to a tax professional about how your specific accident compensation structure affects your tax return.

Mental Distress without Physical Injuries or Illness

The law makes the following clear distinction between emotional distress and physical injury:

“Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.”[5]

If someone experiences depression, PTSD, or other emotional symptoms as a result of a physical injury incurred in an accident, they may receive tax-exempt compensation. However, emotional distress on its own would fall under auto accident settlement taxable income.

Can You Reduce Taxes Owed on a Car Accident Settlement?

Reducing the taxes you pay on taxable income from a settlement or judgment isn’t possible. Before spending any financial reward, talk to a legal or tax professional. They’ll guide you on how to structure the settlement.

Here to Help You Financially Prepare for Your Settlement

Settling your car accident can be a lengthy process. Unfortunately, the costs of living don’t stop during this trying time. Facing bills and other expenses may put a strain on your finances.

Moreover, there’s never a guarantee when it comes to car accident settlement amounts. The reward you receive can vary greatly, depending on the severity of the accident and the state where it occurred.

Car accident victims can also face uncertainty surrounding the resolution of their case. It can take a long time for a case to conclude, but pre-settlement funding can help accident victims cover their bills until they receive any financial award they’re granted.

At USClaims, we offer pre-settlement funding services to people injured by the negligence of others. If you’ve suffered an injury and expect compensation, we buy a portion of the anticipated settlement or jury award proceeds and provide you with cash immediately. The advance is only repaid if your claim is successful or you agree on a settlement. Apply now or call us today at 1-877-USCLAIMS to learn more.

The availability of pre-settlement funding varies by state. Contact USClaims for more information.

Sources

  1. “Tax Implications of Settlements and Judgments | Internal Revenue Service.” Www.irs.gov, www.irs.gov/government-entities/tax-implications-of-settlements-and-judgments.
  2. “Do I Need to Pay Tax on a Car Accident Settlement or Judgment?” Www.nolo.com, www.nolo.com/legal-encyclopedia/do-i-need-pay-tax-vehicle-accident-settlement-judgment.html. Accessed 21 May 2024.
  3. “ARSC News – Spring 2022 Taxable and Non-Taxable Labor for Auto Repairs and Service.” Bureau of Automotive Repair, 15 Apr. 2022, www.bar.ca.gov/arsc/newsletters/newsletter/spring-2022/taxable-and-non-taxable-labor-for-auto-repairs-and-service. Accessed 21 May 2024.
  4. IRS. “Settlements—Taxability.” IRS, Sept. 2023, www.irs.gov/pub/irs-pdf/p4345.pdf#:~:text=Punitive%20Damages:%20Punitive%20damages%20are%20taxable%20and,for%20personal%20physical%20injuries%20or%20physical%20sickness. Accessed 20 May 2024.
  5. “26 CFR § 1.104-1 – Compensation for Injuries or Sickness.” LII / Legal Information Institute, www.law.cornell.edu/cfr/text/26/1.104-1. Accessed 22 Apr. 2024.
  6. “Tax Implications of Settlements and Judgments | Internal Revenue Service.” Www.irs.gov, www.irs.gov/government-entities/tax-implications-of-settlements-and-judgments.
  7. “Sec. 104. Compensation for Injuries or Sickness.” Irc.bloombergtax.com, irc.bloombergtax.com/public/uscode/doc/irc/section_104. Accessed 22 Apr. 2024.
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