Do You Have to Pay Taxes on a Car Accident Settlement?

With most car accident cases, the insurance company pays the victim’s claim within a week or two. However, there is always the chance that the insurance carrier will deny your claim. Or, the at-fault driver’s insurance policy may not cover your losses.

When a person suffers serious physical injuries in a car accident, they will likely have significant damages. (Damages is another word for economic and non-economic losses a person suffers in an accident.) In situations like this, there is always a chance the other driver’s insurance policy limits won’t cover the victim’s losses.

When this happens, you may have to sue the other driver for personal injury. Since most personal injury claims settle out of court, it makes sense to wonder what happens to your settlement money once the case ends.

Here, we’ll describe the types of damages you can demand in your auto accident lawsuit. We will also explain how your car accident lawyer distributes your settlement proceeds and whether this money qualifies as taxable income.

If you’ve recently been in a serious car accident and have questions about your case, contact an experienced personal injury attorney. They’ll review your case and give you an idea of what it may be worth.

Do Most Car Accident Claims Settle Out of Court?

Most people are surprised to learn that less than 5% of all personal injury cases go to trial. This is because settling these types of cases is in the best interest of all parties. Going to trial is expensive and time-consuming; attorneys with years of experience handling car accident claims understand this.

Some of the benefits of settling your case out of court include:

• It can take over a year to go to trial.
• Your costs and fees will be much lower if you settle your case.
• You will receive a lump sum within weeks of signing your settlement agreement.
• You may lose at trial and walk away with nothing.
• Your lawyer can resolve your case in months, instead of years.
• If you win at trial, there’s no guarantee you’ll ever receive your money. You may never see a dime if the other driver has no insurance or assets.

Note: Four states (and the District of Columbia) do not allow plaintiffs to recover damages if they were partially at fault for their car crash. These states follow the “pure contributory negligence” rule, which states that a plaintiff cannot collect damages if they were in any way at fault for the accident. Most states use a comparative negligence approach, where damages are just reduced by the percentage a plaintiff is found to be at fault.

How Do You Know What Your Personal Injury Claim is Worth?

Knowing precisely how much your personal injury case is worth is difficult. No attorney worth their salt will promise to get you a specific amount of money because there is no way to predict the future. Even if the evidence against the other driver is strong, that doesn’t necessarily mean you’ll win your case.

Many factors impact your settlement amount, such as:

• The nature and extent of your personal physical injuries
• Whether you miss any time from work
• Whether you can continue to do the same kind of work after the accident
• The type of medical care you’ll need now and in the future,
• Whether the other driver acted recklessly or with gross negligence (such as drunk driving)
• Your age, income, and health
• Your level of pain and emotional distress
• Your medical expenses
• Your out-of-pocket expenses

Your car accident lawyer will work hard to negotiate the best settlement possible. However, every case is different, so there’s no way to know for sure how much your case is worth.

Types of Damages in a Personal Injury Case

When you file your civil complaint, you must make a demand for damages. Your compensatory damages will depend on the facts of your case. For example, if the only physical injury you suffer is whiplash, your case may only be worth about $5,000. If, however, you suffer a traumatic brain injury, your case could be worth a significant amount of money.

In most auto accident cases, the plaintiff will demand some (or all) of the following types of damages:

• Property damages
• Medical bills
• Lost wages
• Lost income (future)
• Pain and suffering
• Punitive damages

Your car accident attorney can only demand damages that you actually suffer. Furthermore, the courts rarely award punitive damages in car accident cases. They only allow a plaintiff to recover these damages to punish the defendant for their egregious behavior.

Distribution of Auto Accident Settlement Proceeds

Once you file your car accident lawsuit, your car accident attorney will start settlement negotiations with the insurance company. Even though you cannot sue the insurance carrier directly, the law requires that they represent their insured (the other driver) in court.

Once they arrive at a settlement amount, your attorney will draft a settlement agreement with an explicit payment date. Your attorney will distribute the settlement proceeds once they receive your settlement check.

Your car accident lawyer will distribute your settlement money as follows:

• Attorney fees: The law office handling your case receives its contingency fee before anyone else receives their share. The contingency fee is typically between 33% and 40%.
• Costs: The next thing your attorney will pay is the costs associated with your car accident claim. This includes court costs, medical record fees, deposition fees, etc.
• Medical liens: In most personal injury cases, the plaintiff must pay outstanding medical liens. Your health insurance carrier will expect reimbursement for any medical bills related to your accident. The same is true with government insurance, such as Medicaid/Medicare.

You receive the remaining amount. Most plaintiffs receive a lump sum payment when they settle their case. However, there is a chance your attorney may negotiate a settlement that you’ll receive in installments. Your personal injury lawyer will discuss this with you before they draft your settlement release.

The IRS and Tax Implications for Your Personal Injury Settlement

Many plaintiffs ask, “Are car accident settlements taxable?” The short answer to this question is that some of your settlement monies may be taxable, but most are non-taxable. Generally, any money you receive that is directly related to your personal physical injuries or physical sickness is not taxable.

Think of it this way:

• Compensation for harm to your body = Usually not taxable
• Replacement for money you would have earned = Usually taxable

It’s important to understand whether your settlement money counts as a tax liability. When you do your income tax returns, you don’t want to trigger an audit or owe the Internal Revenue Service money.

At the same time, you don’t want to include your entire settlement as taxable income either. Combining this money with your gross income may push you into a higher tax bracket. Since much of your settlement monies is tax-free income, you don’t want to pay taxes on it unnecessarily.

What’s Typically Not Taxable

Under the current tax laws, the following parts of your settlement money will likely be non-taxable:

• Pain and suffering from physical injuries
• Vehicle repairs/replacement
• Medical bills and future medical expenses
• Compensation for physical disabilities or disfigurement

What’s Typically Taxable

The parts of your settlement that will likely qualify as taxable income include:

• Lost wages
• Lost income
• Punitive damages
• Interest earned on settlement money

Gray Areas

Some situations are more complex:

• Emotional distress: Not taxable if it stems from physical injuries, but may be taxable if it’s the primary claim
• Future lost earnings: Harder to quantify, but generally taxable like current lost wages

It’s best to meet with your personal injury attorney or tax professional before signing your settlement agreement. Your car accident lawyer can carefully draft your settlement release to spell out which damages are attributable to your physical injuries.

Bottom line: While most personal injury settlements have significant non-taxable portions, the tax rules can be tricky. Professional guidance helps ensure you comply with tax laws without overpaying.

Ask your attorney to clearly identify which parts of your settlement are for physical injuries vs. lost income. Keep detailed records, and consult with a tax professional before filing your return (especially if you got a larger settlement).

Call an Experienced Personal Injury Lawyer for Help with Your Claim

If you or a loved one has been in a car accident, you may have a claim for damages. The same is true if a family member dies in a car crash. The best way to know for sure is to seek legal advice from an experienced car accident lawyer. You may also want to meet with a tax professional to confirm whether parts of your settlement will be taxable.

Your attorney will review your case and let you know if you should file a personal injury lawsuit (or wrongful death claim). They will also try to negotiate a fair settlement so you can receive your money and move on with your life.

Contact a local personal injury lawyer today and schedule a consultation. Many offer free case evaluations where you can explain your situation and learn your options.