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Are Auto Accident Insurance Settlements Taxable?

Life comes at you quickly, and occasionally that includes vehicle crashes. Driving around minding your own business one minute, dealing with injuries and property damage the next.

Additionally, even though you might be preoccupied with the physical and psychological effects of the event, it's crucial to consider the financial repercussions as well. Your insurance settlement's tax liability can be one of your first concerns. Unfortunately, there isn't a simple solution.

The location where the accident happened and the kind of damages you got are just two of the variables that affect whether or not auto accident insurance payments are taxable. Our Atlanta car accident attorneys have created a list of the most crucial details you need to know to assist you better understand how auto accident insurance payments are taxed.

The Relevant IRS Rule That Applies to Auto Accident Settlements

Publication 4345 (Rev. 11-2021) of the IRS states that "any settlement, judgment, award, or other payment you receive for your personal physical injury or physical illness" is free from taxation.

It's crucial to remember that this rule only applies to physical harm or illness; it has nothing to do with loss of life or limb, emotional distress, or punitive damages.

In other words, if you obtain a settlement for both medical expenses and property damage, only the property damage portion of the settlement will be taxable.

This is so because property damage is not considered a personal physical injury or physical illness by the IRS, but medical bills are.

Taxes on Car Accident Settlements – Here Is What You Need to Know

Now that the fundamentals have been covered, let's discuss how state taxes relate to settlements from auto accidents.

In general, states will tax any compensation you obtain for property damage but not for bodily harm or illness. But it goes deeper than that. You should be aware of the following information regarding state taxes and settlements from motor vehicle accidents:

Car Insurance Settlement for Repair or Replacement of Car or Other Property (Tax-Exempt)

Any amount of an insurance settlement that you utilize to replace or repair your vehicle or other damaged property is exempt from state taxes. Many people find this to be a comfort because it means they will not have to pay taxes on the money they get to fix or replace their accident-damaged car.

Car Insurance Settlement for Personal Injury or Sickness (Taxable in Most Cases)

Most states normally impose taxes on settlements for physical illness or personal harm. To get the greatest outcomes, you should speak with a tax expert in your state to find out how your settlement will be taxed specifically.

Interest Earned on Your Settlement (Taxable)

Generally, you must pay taxes on any interest you receive on your settlement. For instance, if you receive a settlement of $10,000 and deposit it in a savings account that offers 5% interest, you will be required to pay taxes on the $500 in interest you earn over the year.

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Auto Insurance Settlement for Medical Bills (Tax-Exempt)

Your auto insurance settlement for medical expenses may not be subject to taxes. This indicates that you won't owe taxes on this money. It is crucial to remember that the IRS has very clear regulations on what qualifies as a "medical expense" and what does not. Before filing your taxes, you should speak with a qualified tax counselor if you have received an insurance settlement and are unsure of its tax status.

Reducing the Tax Owed on Your Car Insurance Settlement

You can take a few actions to lessen the tax burden on the settlement from your auto insurance claim.

Structured Auto Insurance Settlement

One possibility is to set up your settlement so that the component for physical illness or personal injury is paid out gradually rather than all at once. You will only be taxed on the percentage of the settlement that you get each year, which can help you pay less in taxes overall. Additionally, you might be allowed to deduct your tax-deductible medical expenses from the settlement's taxable component.

Classifying Damages in Your Car Insurance Settlement

Classifying the damages in your settlement carefully is another approach to lower the taxes you have to pay. You can ask for the $5,000 to be counted as "property damage" rather than "medical expenses," for instance, if you have $10,000 in medical bills and $5,000 in property damage. The $10,000 will remain tax-free, while the $5,000 will become taxable.

Frequently Asked Questions About Auto Insurance Settlements

Is Interest Earned on Your Car Accident Settlement Taxable?

The basic rule is that interest generated on your settlement is taxable. Any interest you receive as part of your settlement is taxable income according to IRS Publication 4345 (Rev. 11-2021), so you must include it on your tax return.

Are Punitive Damages in an Insurance Settlement Taxable?

In most cases, punitive damages are not taxed. However, the IRS can see a settlement as taxable if you additionally obtained punitive damages (such as medical expenses and lost earnings) in addition to compensatory damages.

Are Property Damage Settlements Taxable?

The type of property damage settlement will determine the response. In general, this is taxable income if you got cash from the at-fault driver's insurance company. However, this is not taxable income if your settlement includes property, such as a car or other expensive item that was destroyed in an accident and replaced with a new one.

Contact Our Auto Accident Lawyers Today

Contact the skilled personal injury lawyers at The Mabra Law Firm immediately if you have been hurt in a car accident or have sustained property damage as a result of another driver's carelessness. We can assist you in making a claim with the insurance provider and settling the matter fairly.

Call us at (404) 344-5255 to arrange a free case evaluation.

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