Foster City, CA – March 30, 2021 – It’s tax season, and some drivers may be asking, “Are car insurance settlement taxable?” if they’ve recently received one after an accident. Experts know it’s not always cut and dry because there are several components to every settlement. While it may be best to consult a tax attorney, Insurance.com is releasing a guide before Tax Day to help.
Taxable
- Pain and suffering or emotional distress: may be taxable
- Car insurance settlement for lost wages: taxable
Not Taxable
- Typically, money to repair or replace a vehicle is not taxable
- Auto insurance settlement for medical bills: tax-exempt*
Gray Area
- Car insurance settlement for pain and suffering taxable: taxes vary
- If pain and suffering is the result of a physical injury: not taxable
- If pain and suffering is classified as emotional distress: taxable
“Typically, the IRS only taxes money (income) that makes you wealthier than you were before, but there are always exceptions,” notes Ashlee Tilford, the site’s insurance analyst and managing editor.
FAQs
- Is interest earned on car accident settlements taxable?
- If the money from the car insurance company is deposited in a bank account or mutual fund and earns interest – that interest is considered income and is always taxable
- Are punitive damages in an insurance settlement taxable?
- Punitive damages are taxable because they are not compensating a driver for out-of-pocket losses
How to Reduce the Tax Owed on a Car Insurance Settlement
- Structured auto insurance settlements can help save between 25-35%: if it covers future lost wages, consumers can avoid some taxes by having it paid out over an extended period
- The insurance company must purchase an annuity in an amount that will earn enough interest income to replace lost wages (non-taxable)
- The rest paid by the insurance company is taxable
- There are two categories of damages when suing another driver: how a settlement is classified will impact the tax obligation.
- Special damages are easy to quantify - lost wage compensation is always taxable because it is considered income
- General damages are more subjective and include (non-taxable) pain and suffering
* IRS exception - "If you receive a settlement for personal physical injuries or physical sickness, you must include in income that portion of the settlement that is for medical expenses you deducted in any prior year(s) to the extent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro-rata basis the part of the proceeds for medical expenses to each of the years you paid medical expenses.”
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