In general, a personal injury settlement from a car accident is not taxable. The IRS will not tax your settlement if you received a settlement for personal physical injuries or physical illness and no itemized deduction had been taken for medical expenses related to your condition in recent years. However, the taxability of your compensation depends on the reason for the payment.
Whether the IRS can tax your settlement compensation depends on how it is structured. According to IRS Publication 4345, you can be taxed on:
- Personal physical injuries or physical sickness if your report part of the settlement, used for medical expenses, as income and have deducted it for a tax benefit.
- Emotional distress or mental anguish not originating from a physical injury or sickness; the proceeds must be reported, although the total is reduced by amounts paid to medical expenses not previously deducted and those deducted that didn’t provide a tax benefit.
- Proceeds for lost wages related to employment-related lawsuits; a settlement for lost profits from a business or trade is considered net earnings, which is taxable and reported as business income.
- Settlements for loss in property value if the settlement exceeds the adjusted basis for the property, as this excess is considered income. If there is no excess, you do not need to report the settlement in your tax return.
- Interest on any settlement as well as punitive damages, which are taxable and should be reported as income, even if they were part of a settlement for personal physical injuries or sickness.
How to Reduce Your Settlement Tax Obligation
With an experienced car accident attorney in Los Angeles, you can reduce your tax obligation or eliminate it entirely. Examples of strategies to do this include:
- A structured settlement: You can avoid some taxes on a large settlement, such as that covering future lost wages, by agreeing to be paid the proceeds over time. Some of the income payout can be excluded from your current tax obligations. The interest part of payments is non-taxable, while the rest of the money is taxable. This option can save you anywhere from 25% to 35% of taxes on interest income.
- Classifying damages: By classifying damages from a car accident settlement with your insurer, you can receive special damages, such as lost wages, that are easy to quantify and are taxable. General damages, such as pain and suffering, are more subjective and are considered non-taxable.
However, a taxable settlement reported as an increase in income, if you, a spouse, or dependent are covered through the Health Insurance Marketplace, can increase your tax liability. This applies especially if advance payments of the premium tax credit were paid to your insurer.
Keeping the Most of Your Accident Settlement Proceeds
A personal injury attorney can navigate the complex settlement and taxation process, so you keep as much of your proceeds as possible. At Lawsuit Cash 24/7, we know every dollar counts as an injury can leave you in debt and out of work. We can also provide a pre-settlement cash advance with no out-of-pocket expenses. This is paid back only if your case wins—out of your future settlement proceeds. Regardless of your tax obligations, you can receive the money now and, if your case loses, you do not owe us anything.
To learn more or apply for a non-recourse cash advance, with no credit or employment check, and be approved in as little as 24 hours, submit your information online or call us toll free at 866-321-7720.