The fact is that most car accident settlements are not taxed, but as with nearly everything having to do with the law, there are exceptions. The way your settlement is structured plays an important role in whether portions of it will be taxed or not. This is one significant reason why it is important to work closely with an experienced personal injury lawyer if you have been injured in a car accident that was caused by someone else’s negligence.
Those Portions of Your Settlement that Are Tax Exempt
Generally, the damages you receive for the physical injuries you acquired in the car accident are not taxable – as long as you did not take an itemized deduction for any of the expenses related to your injury in a prior tax year (this means that, if you have already received a tax advantage for a certain portion of your settlement, you cannot receive another one on that amount). Damages related to medical bills are similarly tax-exempt. Further, that part of your settlement that is intended to compensate you for the wages you lost as a result of your physical injuries is generally considered compensation and is not taxed as wages (or otherwise).
Those Portions that Are Taxable
Personal injury damages that are awarded under specific categories may be taxable, including:
- Interest Earned – If you earn interest on the settlement you receive from your car accident case, just like interest you earn on your investments, it may be taxable.
- Damages for Emotional Pain and Suffering – Any damages you are awarded for emotional pain and suffering – along with any punitive damages, which are rarely part of personal injury settlements – may be taxable. Nevertheless, damages awarded for emotional pain and suffering that was caused by your physical injuries are not taxable. In other words, it can be very complicated.
Reducing Your Tax Burden
If you have a personal injury claim, you need the settlement amount to adequately cover your damages so that you can make your fullest recovery. The last thing you want to do is to have a generous portion of the damages you are awarded go directly to the IRS in the form of taxes. As such, there are steps you can take to help minimize your tax burden, including:
- Carefully structuring large settlements to minimize any tax consequences.
- Ensuring that your damages are correctly classified to begin with.
Both of these can be accomplished by working closely with a skilled personal injury lawyer.