If you've received a settlement or judgment following a vehicle accident, you're probably wondering, "Do I have to pay taxes on that money?" Here are some short answers; read on for in-depth information:
The first thing to understand is that the same tax rules usually apply whether you received an out-of-court car accident settlement (i.e. a settlement from a car insurance company) after your car accident, or you were awarded money from a civil court after trial (you received a judgment in your favor, in other words).
The applicable language of the Internal Revenue Service (IRS) regulation addressing the question of taxability of settlements and judgments is found at 26 C.F.R section 1.104-1(c):
Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.
Remember that there are federal and state income tax laws and regulations. Most states have adopted rules that are the same or similar to the above-referenced CFR section when it comes to the taxability of personal injury settlements and judgments.
The vast majority of settlements and judgments are for only "compensatory damages" and "general damages." Those categories of damages are meant to compensate you for your medical expenses, lost wages, and the pain and suffering that arises directly from your injuries.
In a typical settlement where you receive only compensatory and general damages for your physical injuries and medical expenses, most of that amount is usually not subject to taxes.
Any compensation you receive for vehicle damage resulting from a car accident is not taxable. This is true for the costs of repairs that were paid as well as any reimbursement you might have received for a rental car while your vehicle was in the repair shop.
Generally speaking, any settlement or judgment amount you receive as compensation for lost income is subject to income tax. The reasoning is that your original income would have been taxable had you not suffered the income loss, so any compensation intended to replace that same lost income should be taxable as well.
If your settlement or judgment includes compensation for other types of losses in addition to lost wages, such as medical bills, you must still pay taxes on that portion of the settlement or judgment that is attributable to the lost wages.
It's rare that punitive damages are included as part of a car accident settlement or judgment. This category of personal injury damages is usually intended as just what the name implies—to punish the defendant, and to deter future bad behavior. These kinds of damages are only awarded in pretty extraordinary circumstances where the defendant has engaged in particularly outrageous or egregious behavior. In the rare even that you do receive punitive damages in a personal injury case, know that those damages are almost always taxable.
Your car accident lawyer should be able to provide basic information on the taxability of your settlement or judgment. But it's important to remember that most personal injury lawyers are not experts in tax law. So, if you've got more complex questions about the tax implications of a personal injury settlement or judgment, it's best to get tailored advice from a tax professional.