When Are Car Insurance Settlements Taxable?
A few ways you could settle your car accident claim are either settling with the car insurance out of court, or taking your personal injury or car accident case to trial for a judgment. Whichever way you decide to go, you will either end up with compensation for your damages or not.
If you are the lucky guy and received a settlement from the car insurance, you are not yet finished as yet! Your car insurance settlement could be taxable! This means that if you got $200,000 as a settlement, you could end up taking home something lower than $200,000. But, when are car accident settlements taxable?
Of course, your settlement is a combination of separate damages aggregated together to form one single amount you will receive as damages to compensate for your losses, due to a car accident or other personal injuries.
Damages that form part of your settlement include medical expenses, lost wages, lost potential to earn, emotional distress, property damages, punitive damages, pain and suffering, and so many others. Now the question is, are all these components of insurance settlement taxed? what components are taxed and others are not taxed?
This article explores the damages you are entitled to, following a car accident or any other personal injury, and clearly explains damages that are taxable or not. Please go through the contents of the article below and look at sections of your interest.
Page Contents
What is car insurance?
I guess most of you guys who have been following the site know everything about car insurance since I already covered lots of stuff about car insurance. If you are new to this site, here is a simplified version.
Insurance simply refers to an agreement or contract between you the policyholder and an insurance company. The agreement states that the policyholder pays a premium in exchange for coverage for accidental or unexpected events like fire, collision, weather calamities, theft, and other liabilities.
Buying car insurance is required by law in almost all states here in the USA. If you caused an accident, your insurance coverage helps in compensating the victims that suffered due to your negligence.
Every day, many drivers are falsely accused to have caused a car accident and ended up paying lots of money. You and I agree that, though some accident fault is clear, in many others determining who is at fault for the accident is not easy and drivers even end up fighting.
To avoid such scenarios, you may choose to install dash cams onto your car. Dash cams record everything during the car accident and you won’t find it hard to prove your innocence. You can go on and choose from the dash cams below.
Common claims for car accidents and other personal injuries
If you are reading this from here in the USA, you should know that a person who negligently or intentionally injures someone pays for the damages and losses caused to the victims.
You either pay from your own pockets or pay through your insurance if you carry the coverage. For instance, If you caused an accident and injured the other party, your liability car insurance compensates the other party.
The person to whom you negligently caused injuries or any other financial losses is entitled to compensation or damages which include the following.
1. Property damages. If the car accident you caused damaged cars or any building, you are liable for these losses. You will need to pay compensation to the aggrieved party. The other person receives a settlement from your insurance company.
2. Medical expenses. No person has a right to injure another one. You will need to reimburse or pay all medical expenses and other related costs incurred by someone you recklessly, or carelessly injured. But, are these medical bills taxable? read on!
3. Pain and suffering. Car accidents cause considerable pain and suffering. If you had a serious car accident, expect to go through pain and suffering for months or years. These include deformities and other incapacitations.
4. Emotional distress damages. Following a car accident, some people develop anxiety, depression, xenophobia, mental anguish, and stress-related disorders. Are emotional damages taxable? read on!
5. Punitive damages. If someone intentionally caused your injuries, the jury or judge could award you punitive damages just to punish the offender for his acts. Are punitive damages taxable?
5. Lost wages. You will lose money during the days you are grounded because you will not be able to work. If you lost 2 years’ worth of income, you should be compensated by the at-fault party.
Do you have to pay taxes on insurance settlements?
Yes, some damage settlements are taxable while others are not. You should basically pay taxes on damages that are not compensatory. You also pay taxes on damages that are directly reimbursing your lost income and wages.
List of taxable insurance damages
Below is a list of insurance settlements on which you will be required to pay tax.
1. Punitive damages. If the jury or judge discovers that you were intentionally injured, or if there was a high degree of negligence, then you could be awarded punitive damages. These are intended to punish the culprit and such settlements are taxable.
2. Lost wages/income. Every person pays taxes on any income so should be damages that compensate for your lost wages or lost income.
3. Emotional distress damages. You won’t pay any tax on emotional distress damages due to your personal injuries, but you will pay the tax if emotional damages are not connected to your injuries. For instance, if a parent receives a settlement on behalf of the child, the emotional distress damages received will be taxable.
How to avoid paying taxes on settlement money?
I do not recommend avoiding paying taxes on settlement money, but there are ways you could reduce the amounts paid as taxes. If you settled with your car insurance, you will most likely receive a lump sum as a settlement.
You will need to report such a settlement with IRS and if your settlement is not properly broken down into components, you could end up paying higher taxes or face problems with IRS.
If you received let’s say $100,000 as your settlement, it should clearly be broken down into single-component damages. For instance, let your car insurance settlement be broken down as follows.
Medical expenses = $40,000
Pain and suffering = $20,000
Emotional damages = $10,000
Punitive damages = $10,000
lost income/wages = $20,000
By doing so, IRS will know how much from your insurance settlement should be taxed. In the above example, only punitive damages and lost income/wages ($30,000) will be taxed instead of $100,000.
Do I have to pay taxes on homeowners insurance payout?
Insurance compensation is only intended to make you whole again after your losses. Any money you receive to compensate for your losses is not taxable. In actual sense, you should pay taxes on any income/profits you earned.
So, you are not supposed to pay taxes on homeowners insurance payout unless you made any profit or earned income reimbursement. Having that said, medical and property insurance claims are not taxed, while life and disability insurance claims, and lawsuit proceeds sometimes are taxed.
Do you have to pay taxes on death insurance money?
Taxes should always be paid on money earned or any profits made. There should be no tax paid on any damages received to compensate for the wrongful death of a loved one. However, if there is any interest earned on the structured damages, expect to pay a tax.
If the damages paid to compensate for a wrongful death includes emotional damages, punitive damages, and lost income or wages, definitely those components will be taxed by IRS.
Total loss car insurance settlement
If it costs more to repair your damaged car compared to buying a similar car at the current market value, then the insurance company will most likely total your car. below is an example.
Suppose your car’s market value is $4,000. You are involved in a car accident and your car insurance claims adjuster estimates that repairing your car will cost $4,500. Your car will be declared a total loss.
You will receive money to replace your car according to the current market value. In some states, your car will be totaled if the cost to repair it exceeds more than 75% of its current market value. Is total loss car insurance settlement taxable?
The answer is no. You won’t pay any tax on the money you received as compensation to replace your totaled car. In almost all states, property damage compensation is not taxable.
How Can an Attorney Help With Car Accident Settlement Taxes
Working with an experienced car accident attorney helps you to reduce the taxes you will pay on your insurance settlement. For instance, assume you were awarded $100,000 as your lost income and wages.
You will pay higher tax if you accepted $100,000 as a lump sum. Instead, your lawyer should help you structure the settlement and be paid over let us say 5 years. Receiving your settlement over 5 years helps you save 50% of taxes you would have paid if you received it as one single payment.
In case you chose not to hire a lawyer, below are 2 books you need to read to understand how to win a personal injury or car accident settlement. Reading the books below will empower you with all the necessary expertise you need to negotiate a settlement with the insurance company.
Conclusion.
Some components of Car insurance settlement are taxable while others are not. Components like punitive damages, lost income and wages, and emotional distress damages are taxable while medical bills, pain and suffering, and property damages are not taxable.
