Personal injury settlements are generally considered to be tax-free. This means that you do not have to pay taxes on the money you receive as a result of a personal injury settlement resulting from a car accident.
This is because personal injury settlements are considered to be compensation for a physical injury or physical sickness. The Internal Revenue Service (IRS) does not consider this type of compensation to be income, and therefore it is not subject to taxes.
Which Tax Code is Applicable?
The most relevant IRS regulation on whether personal injury settlement money is taxable is 26 C.F.R 1. It states, in pertinent part:
§1.104-1 Compensation for injuries or sickness.(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.
However, there are some exceptions to this rule. If a portion of your personal injury settlement is for lost wages, that portion may be subject to taxes. This is because lost wages are considered to be income, and income is generally subject to taxes.
Are Punitive Damages Taxable?
Additionally, if a portion of your personal injury settlement is for punitive damages, that portion may also be subject to taxes. Punitive damages are damages that are awarded to punish the person or entity that caused the injury, rather than to compensate the injured person for their losses. Punitive damages are considered to be taxable income.
It’s important to consult with a tax professional or attorney to determine if any part of your personal injury settlement is taxable and how to report it on your tax return. They may also help you to minimize your tax liability if there’s any taxable part of the settlement.
Are Medical Expenses paid through an HSA or FSA Taxable?
It is also important to note that if you used any pre-tax money, such as health savings account (HSA) or flexible spending account (FSA) funds to pay for medical expenses related to your injury, you may have to pay taxes on the portion of the settlement that is meant to reimburse you for those expenses. This is because the money you used from these accounts was not taxed when you earned it, and the IRS will want to recoup that lost revenue when you are reimbursed for those expenses through your settlement.
Are Damages for Lost Income or Lost Business Taxable?
For personal physical injury cases, portions of the settlement for lost wages are generally not subject to income tax. See 26 U.S.C. § 104(a)(2) and Commissioner of Internal Revenue v. Schleier, 515 U.S. 323, 329-30 (1995).
Is A Settlement Paid through a Structured Settlement Taxable?
Additionally, if you are receiving a structured settlement, which means that the funds are paid out over a period of time rather than in a lump sum, it is important to consult with a tax professional or attorney to understand the tax implications of receiving the funds over time.
It’s important to keep accurate records and documentation of any expenses related to your injury, as well as any payments received from the settlement, in order to correctly report them on your tax return. If you have any questions about how your personal injury settlement may affect your taxes, it is always best to consult with a tax professional or attorney to ensure that you are in compliance with all tax laws.
In conclusion, while most personal injury settlements are tax-free, it is important to understand the tax implications of your specific settlement and to consult with a professional to ensure that you are in compliance with all tax laws. It’s also important to keep accurate records and documentation of any expenses and payments related to your injury.
*Note: You cannot rely on this page as tax advice. As it turns out, we are not tax attorneys either and you also can never be certain that general advice applies to your case.