Is the money I receive in a car accident settlement taxable?
In general, the money that is received from a car accident settlement is not taxable as long as it was received due to a physical injury or physical sickness. The IRS states that:
If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income. (IRS)
If your car accident settlement is compensation for a physical observable injury, then the general rule is it will not be taxable. However, those are difficult quantifiers if the injury may be internal or mental.
The proceeds you receive for emotional distress or mental anguish originating from a personal physical injury or physical sickness are treated the same as proceeds received for Personal physical injuries or physical sickness above.
However, there are circumstances, which deem car accident settlement cash taxable.
When is my car accident settlement considered taxable?
If the proceeds you receive for emotional distress or mental anguish do not originate from a personal physical injury or physical sickness, you must include them in your income. However, the amount you must include is reduced by: (1) amounts paid for medical expenses attributable to emotional distress or mental anguish not previously deducted and (2) previously deducted medical expenses for such distress and anguish that did not provide a tax benefit. Attach to your return a statement showing the entire settlement amount less related medical costs not previously deducted and medical costs deducted for which there was no tax benefit. The net taxable amount should be reported as “Other Income” on line 21 of Form 1040.
In general, the Internal Revenue Service (IRS) will only seek to tax personal injury settlements if the settlement is meant to replace your own income.
Medical Deductions Have Been Performed:
The other specific instance where your personal injury settlement may be taxed is in the event that you have previously claimed medical expenses. if you itemize deductions and you claimed medical expenses in previous years as an itemized deduction that were later reimbursed by the settlement then that amount would be taxable.”
When your case is tried in front of a jury, they are usually told the income is not taxable. If juries were not told that they may be inclined to award extra in order to pay the taxes
In the event that your settlement is meant to replace income (e.g. employment discrimination or lost profits claim from business) then the claim can be taxed.
If you receive a settlement in an employment-related lawsuit; for example, for unlawful discrimination or involuntary termination, the portion of the proceeds that is for lost wages (i.e., severance pay, back pay, front pay) is taxable wages and subject to the social security wage base and social security and Medicare tax rates in effect in the year paid. These proceeds are subject to employment tax withholding by the payor and should be reported by you as ‘Wages, salaries, tips, etc.” on line 7 of Form 1040.
If you receive a settlement for lost profits from your trade or business, the portion of the proceeds attributable to the carrying on of your trade or business is net earnings subject to self-employment tax. These proceeds are taxable and should be included in your “Business income” reported on line 12 of Form 1040. These proceeds are also included on line 2 of Schedule SE (Form 1040) when figuring self-employment tax. For more information about reporting self-employment income and paying self-employment tax, see Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
Loss-in-value of property
Property settlements for loss in value of property that are less than the adjusted basis of your property are not taxable and generally do not need to be reported on your tax return. However, you must reduce your basis in the property by the amount of the settlement.
If the property settlement exceeds your adjusted basis in the property, the excess is income. For more information, see the Instructions for Schedule D, (Form 1040) Capital Gains and Losses and the Instructions for Form 4797, Sales of Business Property.
Interest: Interest on any settlement is generally taxable as “Interest Income” and should be reported on line 8a of Form 1040.
Punitive Damages: Punitive damages are taxable and should be reported as “Other Income” on line 21 of Form 1040, even if the punitive damages were received in a settlement for personal physical injuries or physical sickness.
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