A common question asked, particularly as tax season arises, is whether a settlement from a car accident is considered taxable income. In many types of lawsuits, such as breach of contract cases, discrimination and employment cases, an award may be considered income.
If a person receives a large sum of money due to a settlement, tax consequences must be considered. But in car accident cases where physical injury is involved, the answer is no. It does not matter whether the case was settled before trial or a jury returned a verdict. There are exceptions for certain items of recovery.
Physical Injury Requirement
The IRS has determined that if a person involved in a personal injury lawsuit suffered a physical injury, payment for medical expenses, lost wages, pain, suffering and emotional trauma is not considered taxable income.
The IRS has also stated that emotional distress is not, itself, considered a physical injury. Since most car accident cases involve some type of physical injury, the rule covers nearly all auto accident settlements.
Exceptions to the Non-Taxable Rule
There are a few exceptions to the rule, but these exceptions mostly affect only portions of a verdict or settlement:Interest on the verdict or settlement – If the court happens to award prejudgment interest on a verdict or the settlement provides for pre-settlement interest, the interest portion is taxable. In Oregon and Washington State, prejudgment interest usually is not awarded in a personal injury case. Any interest collected after the judgment is considered taxable. Oregon provides for nine percent interest on judgments and interest is not commonly included in the proceeds.
In most cases, an injured party can rest assured that the settlement proceeds will not be taxed, and can be used in the manner for which they were intended, to compensate them for injuries suffered.