Asking whether you have to pay taxes on a car wreck settlement is a good question and shows you’re really thinking about what’s important — how much money you will net on your car wreck claim.
The answer is it depends on what type of injury is being compensated.
If you are only getting compensation for personal injuries, then the answer is generally “no.” Money paid for personal injuries is generally not considered taxable income.
However, if you are being compensated for lost wages, then that portion of your damages will be taxable income.
Also, the IRS has considered compensation tendered in exchange for a confidentiality agreement to also be taxable income.
The IRS rules regarding the taxability of car wreck settlements are primarily based on the Internal Revenue Code (IRS) and related regulations. Here are some key points to consider when settling your personal injury case:
Physical Injury Exclusion: According to IRS Publication 4345, damages received for personal physical injuries or physical sickness are generally not included in gross income.
Emotional Distress: The tax treatment of damages for emotional distress depends on whether the distress is related to a physical injury or not.If it is related to a physical injury, the damages are typically treated as part of the non-taxable recovery for the physical injury. If the emotional distress is not related to a physical injury, the damages may be taxable.
Lost Wages: Compensation for lost wages is generally taxable as ordinary income, according to IRS Publication 525.
Punitive Damages: Punitive damages are generally taxable, as they are not considered compensation for personal injury or sickness.
We try to advise our clients on whether or not their settlement will include any taxable income and can only do so on a case by case basis.
