Your Auto Accident Settlement and the IRS

Sep 12, 2016

Your Auto Accident Settlement and the IRS

If you’ve been injured in an auto accident, there are so many things to think about, so many steps to take, and such an uphill battle to manage that the last thing you’re probably thinking about is your responsibility to the IRS. Many people don’t even realize that their auto accident settlements are taxable, and are unpleasantly surprised when they are contacted by the IRS. To avoid being saddled with unexpected tax burdens, you’ll want to make sure that you understand what’s expected of you and that your settlement is structured in such a way that you can easily uphold those expectations. This is one way that a North Carolina auto accident attorney can help you after you reach a settlement or favorable judgment in your auto accident claim.

Know How the Tax System Applies To Your Settlement

The first step in being prepared for the demands of the IRS is understanding exactly how your settlement will be taxed. Ultimately, the intention of the settlement or judgment that you receive is to ensure that you are restored to the position you were in before the accident. The tax system is designed to correlate with this intention. Some of your compensation will be taxable and some of it may not be. However, if you don’t report the settlement correctly, you could end up facing penalties and unexpected charges from the IRS. Your attorney can help you to avoid this by discussing the specifics of how your settlement should be reported and how taxes are applies to the various forms of damages that you may receive.

Taxation of Medical Damages

Most auto accident claims will have some form of medical expense recovery and recovery for rehabilitation expenses. This compensation is usually not taxed at all. The exception to this general rule occurs when you have claimed a deduction on your taxes for medical care costs. If you have done this prior to receiving your settlement, then the compensation that you receive for your medical expenses may be subject to taxation. It can be very confusing for those who aren’t experts in North Carolina law to figure out which forms of medical compensation are taxable, so it helps a lot to seek the advice of your auto accident attorney.

Taxation of Pain and Suffering Damages

This is another complex and confusing aspect of taxation related to your auto accident recovery. If you receive damages for pain and suffering, you may or may not have to pay taxes for this compensation, depending on the nature of the pain and suffering. For example, if the pain and suffering damages are awarded due to physical injuries, then you should not have to pay taxes on this. If the pain and suffering damages are awarded for emotional distress, then it is likely that you will have to pay taxes on this. If you receive a combination of the two forms of pain and suffering compensation, then this can make things even more confusing.  Of course, it is difficult to even prove such damages to obtain such a settlement. If you do receive compensation for physical or emotional pain and suffering – or both, you’ll want an experienced auto accident attorney to walk you through the process of reporting this on your taxes.

Taxation of Lost Income and Earning Potential Damages

When it comes to recovering damages for lost income and/or earning potential, you typically will have to report this and pay taxes for the damages received. The reason for this is that your income is taxable, and these damages are intended to compensate the income and earning potential that has been lost due to your injuries. As the income you would have earned or would have been able to earn would be taxable, so is the recovery for those damages. It is also wise to be aware that receiving such damages in a large lump sum may place you in a higher tax bracket, meaning that you’ll have to pay a higher percentage of taxes than you would have on the actual income, had it not been lost due to your injuries. Having said that, it is also possible to receive more in compensation to cover the additional tax liability. Again, this situation can be complex and confusing, but an experienced attorney can simplify it for you and guide you through the process of correctly reporting the damages on your taxes.

Taxation of Exemplary Damages

In the majority of auto accident claims in North Carolina, no exemplary or punitive damages will be awarded. The purpose of awarding such damages in an auto accident claim is not to compensate the victim for losses incurred, but to punish the person responsible for the accident. You will only be eligible to receive punitive damages if the behavior of the responsible party is egregiously negligent or willfully dangerous. An example might be a case of road rage, and abhorrent driving behavior that leads to an accident with associated injuries. These damages, if you do receive them, are always subject to taxation because they are non-compensatory damages. You will need to accurately report this on your taxes.

If you’ve been injured in an auto accident, contact the attorneys at Ted A. Greve and Associates to get a free consultation for your auto accident claim. If you have questions about your settlement and the associated taxes, our experienced Charlotte auto accident lawyers are here to help.