Learn the IRS rules for taxing personal injury damages, when you can exclude those damages from your income, and more.
You received a settlement or won a court verdict following a motor vehicle accident that left you with personal injuries. At some point, you've probably wondered, "Do I have to pay taxes on that money?"
Good news: The answer is "probably not." We'll explain the Internal Revenue Service (IRS) tax rules in some detail. Your state tax law likely follows the IRS rules, if you live in a state with an income tax. Ask your tax advisor for details.
For now, here's what you need to know.
- Usually, you don't have to pay taxes on a car accident settlement or a judgment that compensates you for your personal physical injuries—or for pain and suffering, emotional distress, or even lost wages attributable to your physical injuries.
- Money you receive to get your car fixed or replaced usually isn't taxable, either.
- Payments you get that aren't for your physical injuries, or for losses attributable to your physical injuries, probably are taxable.
- Before you settle your case or go to trial, you should speak to your attorney or to a tax professional for advice tailored to your situation. Proper advance planning might save you some money on your tax bill.
The IRS Rules on Taxability of Settlements and Judgments
The main IRS rules on the taxability of personal injury settlements and judgments are found in 26 U.S.C. § 104(a)(2) (2024). Here, in a nutshell, is the bottom line: Amounts you receive as compensatory damages for personal physical injuries or physical sickness are excluded from your taxable income—meaning they're not taxable by the federal government.
Note that these rules apply to personal injury settlements generally, not just to those involving auto accidents.
What Are Car Accident Compensatory Damages?
When you win a typical car accident case, you'll recover what the law calls "compensatory damages." These personal injury damages fall into two categories.
- Economic damages for out-of-pocket losses. "Economic" damages reimburse you for losses that come out of your (or your health insurer's) pocket, like medical bills, lost wages, amounts you pay for replacement household services, and the like.
- Noneconomic damages for other injuries and losses. "Noneconomic" damages cover losses and injuries that you don't pay for out of pocket, such as pain and suffering, emotional distress, loss of enjoyment of life, and more.
Punitive damages don't compensate you for your injuries. Instead, they punish a wrongdoer for extreme and outrageous misconduct. Because they don't compensate you for your injuries, they're not excluded from your taxable income. Stated more directly, punitive damages are taxable.
Punitive damages are rare in car accident cases. Chances are you won't need to worry about these tax consequences.
Compensatory Damages Must Be for Physical Injuries or Physical Sickness
Only compensatory damages that are paid to you for physical injuries or physical sickness can be excluded from your federal taxable income. So does this mean that noneconomic damages for things like emotional distress or loss of enjoyment of life are taxable? Not necessarily.
The IRS explains in a regulation. "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)." (26 C.F.R § 1.104-1(c)(1) (2024).)
Attribution is the key. If you're hurt in a car accident, you'll probably suffer physical injuries—broken bones, brain damage, torn muscles or ligaments, cuts, bruises, and abrasions—to name only a few examples. When your emotional distress (or similar) injuries are attributable to your physical injuries or a physical sickness, the damages you collect for them likely can be excluded from your federal taxable income.
How to document attribution. How do you make sure that your depression, anxiety, fear, anger, and other emotional symptoms are attributed to your physical injuries? For starters, make sure your health care providers know that you're experiencing these problems because of your physical injuries and pain. The IRS will have a hard time disputing this kind of solid medical documentation.
Second, keep a journal or diary where you record your thoughts and recollections. When you experience emotional distress, be clear that it's because of the physical injuries you suffered in your accident. Keep your entries factual and to the point. A journal or diary won't have the same persuasive force as your medical records, but your writings are a valid source of proof.
Are Settlements Treated Differently Than Judgments?
No. As far as Uncle Sam is concerned, they're the same thing. In other words, the same IRS tax rules apply to both an out-of-court car accident settlement and to money you're awarded by a court after a car accident trial. The IRS isn't concerned with the source of the payment. It's interested in what the payment is meant to compensate you for.
If you enter into a written settlement agreement with the defendant (the party you're suing or bringing a claim against), you can negotiate over how much is being paid for your physical injuries. You can also make sure there's language in the agreement attributing damages for emotional distress and lost income to your physical injuries. The IRS isn't bound by your agreement, but as long as it was negotiated at arm's length and in good faith, it's likely to withstand scrutiny.
Alternatively, this language can be put into a release you sign if you don't have a formal written settlement agreement. Ask your lawyer for more information.
Vehicle Damage Compensation Isn't Taxable
Did you receive a payment to cover repairs to your damaged car, or to reimburse you for your totaled vehicle? That vehicle damage payment probably isn't taxable. As long as the total payment doesn't exceed what the IRS calls your "adjusted basis" in your auto (generally, any cash you paid for it plus the amount of your car loan), the IRS won't tax it.
This rule also applies to payments you receive for loss of use of your car, like amounts to cover the cost of a rental vehicle while yours is in the shop.
What About Payments for Lost Income?
If you were working at the time you were injured, your damages are likely to include some amount for lost income or loss of earning capacity. Are these amounts taxable? Once again, probably not.
As long as your lost income is attributable to a physical injury or physical sickness, those damages are excluded from your federal taxable income. In the unlikely event you suffer an income loss without any corresponding physical injury, any payment you get for that lost income will be taxable.
Get Help With Your Tax Questions
Your car accident lawyer should be able to provide basic information on the taxability of your settlement or judgment. Keep in mind, though, that most personal injury lawyers aren't experts in tax law. So, if you've got more complex questions about the tax implications of your car accident settlement or judgment, or if you need to know whether your state follows the IRS tax rules, it's best to get tailored advice from a tax professional.
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