The IRS has issued guidelines regarding the taxation of personal injury proceeds. Any amount received as a result of a personal injury or wrongful death settlement can be taxable, nontaxable, or partially taxable depending on the type of case and the type of compensation for injuries suffered. However, settlement monies related to the physical injuries you sustain in a car accident are not usually taxable according to Section 104 of the tax code.
The IRS generally categorizes damages in car accident cases into two subsets: compensatory and punitive. Compensatory damages are meant to compensate you for your loss (i.e., the injury you sustained in the car accident). Punitive damages are added to any compensatory damages in situations where the defendant acted recklessly, with malice or deceit, or in any other manner that would justify penalizing the wrongdoer or making an example to others. An example of a car accident case where punitive damages may be awarded is one where the at-fault driver was intoxicated at the time of the wreck.
Below is a breakdown of different categories of damages in car accident cases, along with a brief explanation on whether each category is usually taxable.
Medical expenses
An injured party in Tennessee is entitled to recover for medical expenses reasonably and necessarily incurred in the treatment of the injury caused by the accident. These medical expenses can include hospitalization, surgery, physical therapy, MRI, etc. Medical expenses included in a car accident are not usually taxable. However, if you took deductions on your latest tax return and received a reimbursement, the reimbursement may be taxed.
Pain and suffering
An injured party is also entitled to damages for the pain and suffering they experience related to the injuries received in the car accident. This category of damages is not usually taxable.
Lost wages
Car accident victims often miss work because of the injuries they suffered in the wreck. Lost wages provide these victims with compensation for the wages they would have earned if the accident had not occurred. Because wages are generally taxable income, lost wages are taxable. If you are a business owner, and your settlement includes damages related to lost business income, such monies are generally taxable as well and are also often subject to Social Security and Medicare taxes.
Emotional damages
As referenced above, compensation received for emotional distress and mental anguish originating from a personal physical injury or physical sickness are non-taxable. But if the proceeds you receive for emotional distress or mental anguish do not originate from a personal physical injury or physical sickness, you must include them in your income. However, the amount you must include is reduced by:
- amount paid for medical expenses attributable to emotional distress or mental anguish not previously deducted, and
- previously deducted medical expenses for such distress and anguish that did not provide a tax benefit
Punitive damages
The Internal Revenue Code states that punitive damages may be subjected to taxation. Because punitive damages are intended to punish the behavior of the at-fault party, rather than to help the victim recover, they are usually taxable.