Are Auto Accident Settlements Taxable?

by Gina Corena

Last Updated on September 27,2023

Are Auto Accident Settlements Taxable?

Receiving a settlement when injured in an auto accident means great improvements for the victim’s quality of life. Relief from medical bills, and compensation for property damage and pain and suffering help victims to begin to put the accident behind them and look forward to the future. However, receiving any kind of income raises questions about tax liability, and for auto accident settlements, it may not be clear if the damages received need to be claimed on their income tax returns.

While it’s essential to understand the tax implications of auto accident settlements, it’s equally crucial to be aware of the various legal procedures surrounding such incidents. For instance, many accidents result from distracted driving, which has its own set of laws.

Additionally, understanding the difference between ordinary and gross negligence can play a pivotal role in determining the compensation amount. Moreover, in cases where the accident leads to criminal charges, it’s beneficial to know how a criminal case can affect an injury claim.

The good news is that in general, auto accident settlements do not incur any tax obligations, meaning that the funds awarded can go much further in helping pay for the various expenses that come from being involved in a crash. According to the IRS, most settlements for injuries and sickness are not taxable. Like most tax laws, there are exceptions to the rule. Whether or not the settlement is taxable depends on the reason that compensation was awarded.

Medical Expenses 

A primary reason for an auto accident settlement is the cost of medical care. Hospital stays, surgery, follow-up doctor’s visits, rehabilitation,  medication, and equipment can run into tens or even hundreds of thousands of dollars. Serious injuries can require the need for treatment for years. Fortunately, according to the IRS, the money awarded for out-of-pocket medical expenses is not considered income, so it is not taxable.

Pain and Suffering

When recovering from injuries after an auto accident, medical expenses come in the form of bills, but the experiences of pain and suffering, which prevent an accident victim from working, performing  everyday activities and enjoying life as usual, are not as easily measured. This is why settlements can include compensation  for pain and suffering. Though the amount included in the settlement will vary,  the IRS does not require taxes to be paid on it.

Property Damage

Suffering injuries in an auto accident also means it is likely there is extensive damage to the victim’s vehicle or other property. Losing use of a car not only incurs expenses to repair the car but also renting a replacement in the meantime if needed. Since the portion of a settlement for property damage is reimbursement of expenses, and not income, the IRS does not require it to be taxed.

Lost Income

It is no surprise that losing income from missed work is a consequence of being in an auto accident. Injuries, physical pain and mental distress are all reasons why compensation for lost income might be part of an auto accident settlement. Damages for wages lost while the victim is recovering from their injuries may be awarded, as well as the loss of future wages if their injuries will not allow them to return to work. It makes sense that compensation for lost income is treated as regular income, and therefore has to be reported as part of gross income on a tax return.

Emotional Distress

Experiencing an auto accident is bound to cause a degree of emotional distress. A car crash is a stressful experience and recovering from injuries and worrying about the recovery process are examples of reasons why an accident victim might experience anxiety, depression, mood swings, fear of driving,  or other symptoms of emotional distress. Though victims may receive compensation for emotional distress in Nevada, the IRS distinguishes between different types. If emotional distress arises as a result of physical injuries, the compensation is treated like other compensation for physical injuries and therefore not taxed. However, if emotional distress is not related to physical injuries – for example, the victim has serious anxiety about driving – the IRS will likely require the damages awarded to be treated as income. This distinction can be confusing, so it is always best to contact a personal injury lawyer after an auto accident.

Interest Earned on Settlements 

If a settlement is large enough, it may earn interest if invested. Generally, this is treated like other interest income and has to be reported to the IRS.

Punitive Damages

Nevada is an at-fault state when it comes to auto accidents. Fault is determined by a comparative negligence law, meaning that the driver (or other party) is responsible for damages in proportion to their fault. However, some actions result in punitive damages if the defendant’s actions are more extreme than just negligence. For instance, deliberately acting in a way with disregard for the safety and rights of the victim. Unlike other kinds of compensation, punitive damages are not a reimbursement for expenses incurred because of the accident, and therefore are taxed.

The Settlement Agreement

One of the dangers of drafting a settlement agreement after an auto accident without consulting a lawyer is that all the types of compensation – medical expenses, property damage, pain and suffering, emotional distress, and punitive damages – may be combined together, making it very difficult to assess which portion is subject to taxation. There is a risk of either overpaying or underpaying taxes owed on the settlement, and if the IRS disagrees with the assessment, it will be up to the victim to prove that the figures are accurate.

When the settlement agreement is drafted, a lawyer will classify the damages into categories so that they can be accurately reported on the victim’s tax return. For example, if a settlement is awarded for $140,000, it could be divided as follows:

  • $35,000 for medical bills
  • $14,000 for property damage
  • $55,000 for lost wages
  • $20,000 for pain and suffering
  • $16,000 for emotional distress not arising from an injury

The portion of the settlement for medical bills, property damage, and pain and suffering  ($69,000) would not need to be reported as gross income to the IRS. The portion for emotional distress and lost income ($71,000) would be considered taxable. It is advisable to work with a tax professional when filing taxes to make sure the figures are accurate.

Consulting a Lawyer After an Accident 

Being injured in an auto accident can be a traumatic and stressful experience, and not only do you have to deal with recovering from your injuries, there can be large expenses to deal with related to medical bills, lost income, and pain and suffering. You need an experienced car accident lawyer in las vegas and aggressive legal team to fight for your rights and help you to get the settlement you deserve. Contact us for a consultation and let us help you on the road to recovery.

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