Clients frequently ask me if an insurance settlement or personal injury settlement is taxable. The answer is no. Neither the federal government nor your state government can tax you on personal injury settlement proceeds. This means that if you are in a car accident and settle your case with the other side’s insurance company, you do not have to pay Uncle Sam anything on the money you receive. This money is not taxable because it is compensation for you injuries, lost wages, medical bills and pain/suffering.
In reality, you are not making a profit or earnings by settling a personal injury case. You are instead being compensated for injuries and losses caused by the negligence of another party, the wrongdoer or at fault party. It makes sense that you should not be taxed on monies that are not considered earnings or profit. Settlement money tries to put you back into the same position you were before your accident. So, it is not like selling your house and you get taxed on the profit. You are not making a profit, but being “compensated” for your injuries and medical bills.
The Internal Revenue Service (IRS) regulation addressing the question of taxability of settlements and judgments is found at 26 C.F.R 1. It reads in part as follows:
§1.104-1 Compensation for injuries or sickness.
(c) Damages received on account of personal physical injuries or physical sickness—(1) In general. Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness. Emotional distress is not considered a physical injury or physical sickness. However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2). Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress.
Likewise, if you receive money from an insurance company to compensate you for the property damage to your car as a result of an accident, this money also is not taxable. This would include money for the cost or repairs and the amount of money received for rental car expenses. There is usually only one situation where settlement or verdict money will be taxable and that is in regards to punitive damages. Punitive damages are very rare in personal injury cases and are intended to punish the at fault party for very reckless or egregious behavior. Punitive damages are taxable but again, this type of damages are extremely rare when it comes to the typical personal injury or car accident case.
A personal injury lawyer with over 10 years of experience, Ryan Malnar serves Colorado Springs with honesty & integrity.