Are you expecting a settlement following a car accident? If so, you might be wondering whether you have to pay taxes on the expected compensation amount.
So, are auto accident settlements taxable? In most cases, you won’t have to pay taxes on your car accident insurance settlement. But as it is common in tax law, there are exceptions to the general rule.
Everything depends on the damages you were compensated for in your settlement. Settlements for physical injuries and illnesses are typically non-taxable (assuming you did not claim an itemized deduction for the particular injury in prior years).
This tax exemption should save you significant money, enabling you to use your entire settlement on your feet again.
Read on to know what auto accident settlements are taxable and what applies to your situation.
Taxes on Auto Accident Settlements
Some auto accident settlements are subject to taxation. For example, compensation for such damages as lost income or mental distress is taxable.
However, the part of the settlement that covers your medical expenses, property damage, and pain and suffering is tax-exempt.
Based on how you name and organize your settlement, a part of an auto accident insurance payout could be subject to taxes. That’s why consulting an attorney is essential before you resolve your case.
How Do I Reduce Auto Accident Settlement Taxes?
You can lower taxes on your auto accident settlement by organizing your settlement to avoid triggering tax liabilities.
For instance, compensation for medical expenses is not taxable. So, if you can, categorize the settlement as compensation for medical needs.
Additionally, classifying your settlement as reimbursement for pain and suffering exempts it from taxation since pain and suffering result from bodily injuries.
If you end up with some tax obligations, you can lower them by stretching out payments over a more extended period so that no year has a higher taxable income.
What Are the Taxes on Claim Settlements?
Taxes on claim settlements depend on what the actual settlement is meant for. Some are subject to taxation, while others are not.
Compensation is taxed according to the regular income tax brackets when it is taxable. If you get the settlement as a lump sum, you may pay higher taxes depending on your average household income.
Claim settlements are taxed at the same rates applied to other cases, apart from tax-exempt parts.
Non-taxable auto accident settlements
Tax-exempt auto accident settlements include:
- Prescriptions
- Emergency medical care
- Surgeries and diagnostic procedures
- Physical therapy
- Laboratory work
- Pain and suffering
- Property damage
Taxable auto accident settlements
Taxed auto accident settlements include:
- Punitive damages
- Lost wages
- Emotional distress
- Interest
Are Punitive Damages Taxable?
Yes, they are. According to IRS Publication 4345, punitive damages are taxable and should be disclosed as income.
The U.S federal tax law requires punitive damages to be classified as “other income.” The recipient should pay taxes on them as income and report them on a 1040 tax form.
Are Property Damage Settlements Subject to Taxation?
No, settlements for property damage are not subject to taxation. That means you won’t have a tax liability on your compensation if you get a settlement for property damage from a car accident.
Generally, you are being compensated for the lowered value of your property. If that money were taxed, you would not be paid for the total value of your accident-related loss.
Tax law acknowledges that taxing a victim’s compensation for property damage is unfair.
Structuring Your Auto Accident Settlement
Taxes on auto accident insurance settlements vary. Before settling your auto accident claim, it’s crucial to understand your tax liabilities. That’s because the pay structure greatly influences tax liability.
Regarding the effects of an auto accident settlement on taxes, you must be conscious of several things. For instance, reimbursement for medical expenses is often exempt from taxation.
But the narrative does not end there. You cannot be reimbursed for your medical bills and a tax deduction if you list your deductions for medical expenses on your taxes.
You can handle this usually complicated settlement process with the help of an expert personal injury lawyer.
A Lawyer Can Help with Auto Accident Settlement Taxes
Hiring a lawyer before settling your auto accident claim might help you save on taxes. Consider a scenario where you receive $50,000 in settlement for lost capacity to earn and lost wages.
As a single filer, you will incur an income tax rate of up to 24% if you accept a lump sum payment. You will thus be required to pay income tax at a rate of 24% on a share of the money!
Now imagine that you spread out the settlement over five years. You are given payments totaling $20,000 per year for these five years. In this case, your maximum tax rate will be 12%.
In other words, you can save 12% tax by delaying the settlement payment for some time. When you hire an experienced lawyer, you have a professional to assist you with every detail.
In addition to assisting you in negotiating the best settlement terms, an attorney may also help you structure the payment so that you receive the most money.
Additionally, they can assist you in securing your compensation for the auto accident. When you engage with an attorney, you may rest easy knowing that you’ve handled your auto accident compensation best.
Have Any Questions About Taxes on Auto Accident Settlements?
So, are auto accident settlements taxable? You are on the right path if you are curious about how taxes could affect your car accident settlement amount.
Legal Giant can connect you with a skilled lawyer to help you reduce your tax liability. The sooner you engage our partner car accident lawyers in your case, the sooner they can do everything possible to maximize your compensation.
Contact us at (855) 740-5024 for a free, no-obligation with a knowledgeable auto accident attorney.
