Are car accident settlements taxable?

In most cases, car accident settlements are not taxable, but some parts of a settlement can be. Whether you have to pay taxes depends on what the settlement money is meant to cover, such as medical treatment, lost income, property damage, or punitive damages.

If you’re recovering from a car accident in Orlando, this question often comes up at the same time you’re dealing with uncertainty about what comes next. Understanding how different parts of a settlement are treated under tax law—and how an Orlando car accident lawyer fits into that process—can help you plan more confidently for your recovery.

What compensation is usually included in a car accident settlement?

A car accident settlement is designed to compensate you for the losses caused by the crash. This can include medical expenses, lost income, vehicle repairs, and the physical and emotional impact of your injuries.

Because a settlement often covers more than one type of loss, it may be made up of several parts. Each part of a car accident settlement can be treated differently for tax purposes, which is why it’s important to understand how the compensation is categorized.

How the IRS looks at settlement amounts

For tax purposes, the IRS looks at why the settlement money was paid, not just the total amount you received. In its explanation of tax implications of settlements and judgments, the Internal Revenue Service (IRS) divides settlements or trial awards into three categories: 

• Damages resulting from physical or non-physical injury
• Emotional distress damages arising from the physical or non-physical injury
• Punitive damages

Additional components of a settlement include compensation for property damage and lost wages. Some settlement categories and components are tax-free, while others are taxable. Sometimes, the tax implications depend on the specifics of the situation.

Compensation for physical injuries is usually tax free

Compensation for physical injuries or physical sickness is generally not taxable under federal tax law. This includes money meant to cover medical care and pain and suffering related to those injuries.

Emotional distress damages are also usually not taxable when they stem from a physical injury. However, emotional distress that is not tied to a physical injury may be treated differently for tax purposes.

One important exception involves prior tax deductions. If you previously deducted medical expenses related to the accident and later receive compensation for those same expenses, part of the settlement may need to be reported as income.

Are lost wages from a car accident settlement taxable?

Lost income can be confusing from a tax standpoint. In general, lost wages that are paid as part of compensation for a physical injury are not taxable, because they are considered part of the injury-related damages.

However, how lost income is categorized in the settlement agreement can matter. This is one reason it’s important that settlement documents accurately reflect what the compensation is covering.

When is property damage compensation taxable?

Some of your car accident settlement may be for property damage. Your vehicle may need repair or replacement. Under IRS guidelines, compensation for the “loss in value of property that is less than the adjusted basis of your property” is generally not taxable and does not need to be reported as income. Tax treatment depends on what the settlement payment is intended to replace.

If the compensation received is more than the adjusted basis of the property, the excess amount may be treated as taxable income. In situations like this, reviewing the details of the settlement with both your attorney and a tax professional can help ensure everything is reported correctly.

Are punitive damages from a car accident settlement taxable?

Sometimes, settlements or trial awards include punitive damages. When we discuss compensatory vs punitive damages, the functional difference is their purpose. Compensatory damages make up for your losses. They work to restore you to the extent possible to your pre-accident situation.

Punitive damages, however,  are not meant to compensate you, but to punish the at-fault party for an act of particularly reckless or egregious conduct. Punitive damages are a monetary penalty paid by the at-fault party to you. They are ‌also taxable, representing a second difference from compensatory damages.

You must report the amount received for punitive damages as “other income” when filing your taxes. This requirement applies even if the damages were issued because of your extensive physical injuries.

Is interest earned on a car accident settlement taxable?

While settlement funds themselves may not be taxable, any interest earned after the money is paid to you is considered taxable income and must be reported as interest income on your tax return.

Get clarity after a car accident settlement

Questions about taxes often come up at the same time you are trying to recover from an accident and regain stability. DWK Law helps injured people in the Orlando area understand their legal options and what to expect at each stage of a car accident claim. If you have questions about a settlement or how it may be structured, you can contact DWK Law at (407) 244-3000 or contact us online to discuss your situation.