Are Settlements Taxable After A Car Accident?

Are settlements taxable after an auto accident? The answer to that question is more complex than a simple yes or no. Car accident lawsuits have the potential to result in compensation for the victims. When they do, victims are often curious and want to understand whether or not their settlement is subject to taxation.  A car accident attorney from Labrum Law can help accident victims manage their settlements. Contact us at (615) 338-9500 to speak with one of our experienced personal injury lawyers today regarding your specific situation.

Understanding the Types of Car Accident Compensation

The compensation a car accident victim is awarded in a lawsuit is based on the losses they experienced due to the crash. The most common types of damages include the following:

• Medical expenses. Monetary awards for medical expenses can cover all accident-related medical bills including emergency care, doctor's appointments, physical therapy, and medication.
• Lost wages. Compensation for lost income is awarded in the event an accident victim is unable to work while recovering or cannot return to work in their previous capacity due to debilitating injuries.
• Pain and suffering. Pain and suffering is a legal term of art that encompasses all of the physical pain and emotional anguish endured by an accident victim during the accident and throughout their recovery process.
• Punitive damages. Punitive damages are rarely awarded in car accident cases, but they are possible if the at-fault driver's actions were grossly negligent. For example, someone who caused an accident while under the influence of alcohol could be asked to pay further damages to the victim to deter them from making similar mistakes in the future.

In terms of who pays for those monetary damages, it is usually the at-fault driver or their insurance company. If the driver does not have insurance, the victim's uninsured/underinsured motorist coverage could apply.

Lawsuit Settlements and IRS Regulations

Car accident victims who win or settle a lawsuit may be unaware of their tax obligations until they receive a 1099 form in the mail. To prepare for any required tax payments ahead of time, it is essential to understand how the IRS handles personal injury settlements.

For starters, whether taxes are owed or not depends on the origin of the claim. For example, most car accident victims' compensation is nontaxable because most of their damages are not income-related. However, when allocated in different ways, damages can impact whether or not a portion of a settlement is taxable. 

There is also the matter of how you pay your attorney. If, for example, your lawyer operates on a contingency fee basis and they win your case or help you reach a settlement offer, 100% of the compensation you receive is taxable. However, the dynamics of every case are different, so it is important to consult with your attorney, so you understand what to expect come tax time.

When someone is trying to focus on recovering physically, emotionally, and financially from a car accident, the last thing they want to worry about is failing to comply with federal laws. Fortunately, the car accident attorneys from Labrum Law can help and always work on a contingency fee basis.

Taxable vs. Nontaxable Lawsuit Compensation

Monetary awards from car accident lawsuits are typically separated into two categories: taxable and nontaxable. Therefore, accident victims need to understand the difference and comply with applicable laws during tax season.  

Taxable Compensation

In most instances, the answer to the question "are settlements taxable when related to a car accident?" the answer is no. However, there are exceptions, which include the following: 

• Lost Wages. Any amount of compensation for lost wages is taxable because that income would have been taxed if it had been earned in the normal capacity. Thus, lost wages are subject to not only income tax but Social Security and Medicare taxes, as well.
• Punitive Damages. Punitive damages, which serve to punish the at-fault party for their negligence, are taxable and can have an impact on any taxes on attorney fees.

Nontaxable Compensation

• Physical Injury Awards. Personal injury settlement awards for physical harm and injury are not taxable, so long as the injuries are considered "observable bodily harm."
• Medical Expenses. So long as itemized deductions were not taken for medical expenses related to the accident in prior years, hospital bills, emergency care costs, etc., are not taxable. However, per the tax benefit rule via the IRS, if a plaintiff is reimbursed for medical expenses after taking a deduction, they are required to pay taxes on the sum.
• Emotional Distress. Compensation awarded for emotional distress, sometimes referred to as pain and suffering, is nontaxable so long as the distress derived from physical injuries related to the accident.

Other Factors Affecting Settlement Taxes

While the compensation types listed above are the most common to come across when dealing with taxation and car accident settlements, there are unique situations plaintiffs could run into.

For example, some states require interest to be tacked to the settlement total for the time payment is pending. Any interest added is typically considered taxable by the IRS. So, if a plaintiff is successful in court but the defendant files an appeal, payment could remain pending for months or years. Any interest added to the verdict that was not paid through appeals can be taxed.

In the event a car accident settlement does not involve any injury-specific damages, which is rare, any settlement payout is considered taxable. So, if a car accident victim received compensation for lost wages and property damage, they would be required to pay taxes on their award the following year.

Protecting and Preserving Your Settlement Money

While most car accident settlements are nontaxable, it is important to understand how laws and regulations apply to your specific settlement. Failing to abide by any tax obligations could spell trouble, and monetary penalties, in the future.

Understanding the taxation of a car accident settlement can be confusing—particularly when a personal injury plaintiff has been awarded multiple types of compensation. If you are curious and are left wondering, "are settlements taxable?" Labrum Law can help. To learn more about your legal rights and obligations regarding lawsuit compensation, contact our experienced and compassionate attorneys today at (615) 338-9500.