Do You Have to Pay Taxes on Car Accident Settlements?
Statistics reveal most people will be in at least one car accident in his or her lifetime. Knowing what to expect from the process is essential for a victim of negligence to protect his or her right to compensation. One of the most common questions we hear from clients is, “Will my car accident settlement be subject to tax?”
The simple answer: it depends. A settlement may be taxable depending on what a victim uses it for and the type of compensate they seek in the first place. A portion of a settlement to compensate for medical bills or the cost of future care may not face taxing. Lost wages, on the other hand, may be subject to the same tax as would be applicable to the work itself.
Once you successfully resolve a car accident claim, you might think you have nothing left to do but enjoy your payout. Many crash victims, however, must take additional steps before they can use a settlement to pay off their debts – including paying taxes.
You may owe taxes on a car accident settlement in Kansas City depending on the type of damages you recovered. The IRS will tax certain parts of a settlement, but not others. If you are unsure about the taxation of your settlement, speak to a Kansas City car accident lawyer for tailored advice.
Taxation Depends on the Type of Damage Award
The Internal Revenue Service has a law in place regarding if, how and when it will impose taxes on personal injury settlements. The main points of the law are found in 26 Code of Federal Regulations (CFR) section 1.104-1. This rule states that, in general, the IRS will not tax compensatory awards in settlements. The point of a settlement is to reimburse you for your losses. Exceptions to the rule exist, however. Taxation will depend on the type of damages reimbursed.
Compensatory damages to reimburse your medical expenses are generally tax-exempt. The exception is if you paid for your medical bills and deducted them on your taxes in a prior year. If you previously deducted medical expenses relating to your car accident, you must pay taxes on that part of your settlement. Otherwise, you would be receiving double exemptions for the same expense.
Any amount you receive to repair your damaged vehicle will not be eligible for taxation. Compensation for vehicle repairs, as well as any amount you may have secured for a temporary rental vehicle, is not taxable. The IRS will not tax these amounts since they are compensable damages aimed at reimbursing you for out-of-pocket expenses.
Economic damages for lost wages are typically taxable. The IRS imposes taxes on lost wage awards because you would have had to pay taxes on regular wages if the accident had not occurred. Since regular wages are taxable, so are lost wage awards in car accident claims. You may have to pay higher taxes than normal on a settlement if you receive compensation for multiple years of lost wages.
Noneconomic damages refer to pain and suffering, lost quality of life, mental distress, emotional harm and psychological damages. Taxation on noneconomic damages depends on the situation. If you received this damage award because of a physical injury, you will not pay taxes. If you recovered noneconomic damages for emotional distress, however, you will have to pay taxes on this amount.
A judge in Kansas City may order punitive damages if your case involved gross negligence. Punitive damage awards are relatively rare. As a general rule, punitive damages are taxable. You would have to pay taxes on any additional award you receive because of the defendant’s malicious actions or wanton negligence.
Some car accident settlements will involve interest to make up for claims that take an excessive amount of time to resolve. Interest penalizes the defendant for taking so long to settle a claim. In these cases, the IRS will impose taxes on any compensation you receive as interest added to a settlement.
These are general rules that may change according to the situation. Only a personal injury lawyer or tax professional can give you counsel about the taxation of your specific car accident settlement. In general, however, you will only have to pay taxes on certain parts of your car accident settlement: lost wages, emotional damages, punitive damages, interest and possibly medical expenses. Paying taxes on a car accident settlement can be complicated. Work with a professional for assistance.