Non Taxable Settlement Compensation

A large portion of legal compensation is designed to make the injured victim ‘whole’. The theory of making a victim ‘whole’ is a key concept for understanding how car accident settlement compensation will be taxed. Essentially, compensation is meant to put the injured victim back in the position that they would have been had the car accident never occurred. Under the Internal Revenue Service tax code, the portion of your settlement that is meant to cover your losses, will generally not be subject to state or federal taxation.

  • Property damage: If your vehicle was damaged, or totaled, you will not be taxed on compensation meant to cover that damage.
  • Medical expenses: Compensation for medical expenses, including rehabilitation costs, will generally not be taxed. This portion of the settlement is also designed to make you ‘whole’. But, there are some exceptions to the general rules here. If you have already taken a tax deduction related to your car accident medical expenses, then you may be subject to some taxation on that part of your accident settlement.

Taxable Settlement Compensation

  • Lost wages: Car accident compensation that is included because of lost wages will be subject to taxation. The theory behind this is that you would have been taxed on those wages had you never been injured in a car accident. Therefore, making you ‘whole’ means that you will still owe taxes on those wages.
  • Punitive damages: Compensation for punitive damages are also subject to taxation. In Texas car accidents, punitive damages are only awarded when gross negligence is involved. The most common example is a drunk driving accident. Texas juries are known to award injured DWI accident victims punitive damages. Unlike most other forms of compensation, punitive damages are not designed to make the victim whole. They are designed to punish the bad actions of the negligent party. Therefore, the IRS treats compensation for punitive damages similarly to normal income.

Pain and Suffering versus Emotional Distress

In some Texas car accident cases, you may be entitled to compensation for pain and suffering, emotional distress, or both. This is the most complicated car accident settlement tax issue. The two concepts may sound similar, but there is an important legal distinction. Further, these types of compensation are generally taxed differently.

  • Pain and suffering: Compensation for pain and suffering is excluded from taxation under the IRS physical injury rules.
  • Emotional distress: Damages for emotional distress, such as depression and anxiety are subject to taxation. This is because non-physical injuries are not included in the IRS tax exemptions. However, if you have medical expenses due to your mental distress, those expenses will be excluded from taxation.

Contact Our Office Today

It is important to understand the tax implications of your car accident settlement. An experienced Texas car accident attorney can help you prepare and structure your settlement with tax concerns in mind. If you have any questions about car accident settlement taxation, or car accidents in general, please contact our San Antonio office at (210) 308-8811 to learn more.