You’ve received, or are about to receive, a settlement check for a car accident claim, slip & fall or some property damage and you may be wondering… “Are my personal injury insurance settlements taxable ?"
Well, before we get to that, congratulations are in order. You’ve unsuccessfully navigated the sometimes frustrating and painstaking process of filing an insurance claim.
But the big question remains “Does Uncle Sam get a piece of your settlement ?” The short answer is: Insurance benefits and settlements for home and auto insurance claims are generally NOT considered to be taxable income. Great news! Well yes, but like so many things in life this question isn’t purely black and white.
Below we’ll dig in a bit deeper, and do our best to translate “accountant speak” into simply understood bullet points.
Insurance settlements are taxable depending on what the money is intended for. Settlements tend to break down in the following ways:Is money for lost wages taxable?
So, let’s get started….
If your intuition is telling you that the lost wages portion of an insurance settlement is taxable you are correct. The logic here isn’t too hard to follow: You are taxed on your regular wages so you are also taxed on money meant to replace those wages. Whether this comes in the form of a jury award or direct settlement is irrelevant.
Many different types of insurance settlements will involve some form of medical expense. In the case of money being allocated to cover these medical costs, the general rule is that no tax needs to be paid. This money only becomes taxable if you deduct said expenses on your tax returns.
What constitutes a qualifying medical cost you might be wondering? The Internal Revenue Service defines it in the following way:
“Medical expenses incurred to diagnose, cure, treat, mitigate or prevent a disease, or for the purpose of affecting any structure or function of the body."
Sometimes you may be forced to pay out of pocket for doctor visits while your claim is pending. Be sure to remain aware of whether or not you’ve taken these expenses as deductions, and that’s about all you need to remember -- simple enough.
A bit of a gray area in terms of taxability, the simplest way to think of taxes in regard money awarded for pain and suffering, is the following:
While how exactly this is determined is a whole other matter altogether, the bottom line is that however your pain and suffering is defined by the court is how your tax burden will break down.
Whether your claim is due to an auto accident or water damage to your home, generally speaking, settlements for property damage are deemed tax free. This is simply because this money is meant to reimburse you, and return your property to the value it had before the accident.
In terms of an auto accident this would be the “actual cash value” or bluebook of the car, and with a homeowners claim it would be the adjusted value (estimated) of the property.
If you’d like to read some of the actual law, here is a good place to start. There are many other exceptions through various contexts of insurance settlements, but these are the basics, and because we can almost hear your eyes glazing over we’ll leave it there.
One final (and extremely important) question to address is how are these expenses broken out? When you get a check from the insurance company it is generally just a lump sum, no itemization.
Categorizing expenses in an insurance settlement is left to the subjectivity of the individual and not typically enforced by the IRS. However, not properly paying taxes on the yield of a settlement has triggered more than a few audits – so proceed with caution.
We hope you’ve now got a clearer idea about how taxes tend to go in insurance settlements – if ever in doubt seek professional advice.
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