In general, you do not pay taxes on a settlement you receive for a car accident in Texas. Compensation awarded for losses such as your medical bills, property repairs and lost wages are not taxed by the state or federal government in Texas. However, you could owe taxes on punitive damages, interest earned and certain types of emotional distress compensation. Speak with an experienced car accident lawyer in San Antonio for legal guidance.
What Parts of a Car Accident Settlement Are Not Taxed?
For tax purposes, the majority of a settlement or jury verdict awarded for a car accident is not considered part of the individual’s gross income under Internal Revenue Code Section 104(a)(2). Therefore, they are excluded from taxation. However, payments for certain types of damages in a car accident settlement may be subject to taxes.
Generally, the following parts of a car accident settlement are non-taxable:
- Medical expenses, as long as they were not deducted in prior tax years
- Lost wages and future capacity to earn
- Property damage repairs (or replacement)
- Out-of-pocket costs, such as travel or transportation
- Pain and suffering, if connected to a physical injury
- Disability or disfigurement compensation
- Loss of consortium (for family members)
It is important for a car accident settlement agreement to clearly categorize what each amount is being awarded to the plaintiff for. This is because while the majority of a personal injury settlement is not taxable under the rules of the Internal Revenue Service (IRS), there are some exceptions.
Exceptions: Portions of a Settlement You May Have to Pay Taxes On
Federal law states that “the amount of any 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” is excluded from gross income for tax purposes.
Within this rule, however, there are certain exceptions:
- Punitive damages. Any additional compensation awarded to punish a defendant for acts of gross negligence, maliciousness, recklessness, fraud or intent to harm – known as punitive or exemplary damages – is taxed under federal law.
- Emotional distress, if it is not connected to bodily injury. Compensation awarded for mental distress, post-traumatic stress disorder, depression, anxiety and other mental health conditions due to surviving or witnessing a car accident (or losing a loved one), without arising from a physical injury, is subject to taxation.
- Interest. If the defendant does not pay a settlement right away and it accrues interest from the time of injury to the date of the first payment, any interest earned is taxable.
If portions of your car accident settlement in Texas are subject to taxation, you will be responsible for paying the correct amount of taxes on these values. It is important to be aware of any tax obligations you have as the recipient of a car accident settlement to avoid facing IRS tax penalties.
Working With a Car Accident Lawyer Can Minimize Your Tax Obligations
An injury attorney in San Antonio can help you structure and document your settlement in a way that minimizes its taxation as much as possible. Proper settlement structuring is critical, as this will clearly label which portions of your settlement are taxed and not taxed. Clear documentation can avoid potential tax traps and save you from unwelcome surprises come tax time.