Are Car Accident Settlements Taxed?

If you were seriously injured in a car accident and your lawyer secured a settlement, you might be wondering how that money will affect your taxes. Are you required to report the settlement to the IRS? Are they going to tax the settlement?

It depends on what aspect of settlement you’re talking about. Some parts of a car accident settlement cannot be taxed, and other parts can be taxed, depending on their purpose and the structure of your settlement.

Below, we answer common questions about taxation and personal injury settlements, including what can be taxed, what’s not taxed and other things you need to know. If you have further questions, you should discuss your settlement with your auto accident attorney in Charleston. 

Is My Car Accident Settlement Taxable?

Generally, the IRS does not tax personal injury settlements that compensate victims for physical injuries or physical sickness. In other words, if your settlement covers things like medical bills or pain and suffering caused by a physical injury, it’s usually tax-free.

However, there are important exceptions you need to be aware of.

Which Parts of a Settlement are Tax-Free?

Here is a list of the parts of a car crash settlement that are usually exempt from taxation:

• Medical Expenses: Compensation for doctor visits, surgery, physical therapy, or hospital bills is generally not taxable.
• Pain and Suffering: Compensation for any emotional distress or mental anguish that is directly related to a physical injury is typically not taxed.
• Lost Wages (in some cases): If you were compensated for lost wages because your injury left you unable to work, this money might not  be taxed. Unfortunately, this issue is complicated.
• Property Damage: The IRS generally doesn’t tax compensation you received for repairs or replacement of your vehicle or personal property—as long as it doesn’t exceed the adjusted basis of the property.

What Parts of an Auto Accident Settlement Are Taxable?

Now here’s where things get more complicated. Some portions of a settlement may be taxed, depending on how the settlement is broken down:

1. Emotional Distress (Not Tied to Physical Injury)

If your claim involves emotional distress but no physical injury, the IRS may consider it taxable income. This often happens in claims that involve mental anguish, anxiety, or reputation damage that is not connected to a physical injury.

2. Lost Wages (Sometimes Taxable)

If your settlement includes lost wages as a separate component—such as compensation for missing work or lost earning capacity—this portion may be taxed as if it were regular income. That means it could be subject to income tax and payroll taxes (Social Security, Medicare, etc.).

3. Interest on the Settlement

If you receive interest on your settlement (for example, if the payment was delayed and interest accrued), the IRS considers that interest income to be taxable.

4. Punitive Damages

Punitive damages are always taxable, regardless of the nature of the claim. These are awarded not to compensate the victim, but to punish the wrongdoer for especially reckless or intentional behavior. The IRS sees this as income.

Reporting the Settlement to the IRS

Most injury settlements aren’t reported to the IRS if they’re strictly for physical injuries, but you should always consult a tax professional to be sure. In some cases, you may receive a Form 1099-MISC if part of your settlement is taxable—especially for punitive damages or interest payments.

If you’re unsure how your settlement is broken down, your attorney may be able to provide a settlement statement outlining the allocation.

What About Structured Settlements?

Some people receive their settlements in periodic payments rather than one lump sum. This is called a structured settlement.

The good news is that structured payments meant to compensate for physical injuries are still generally not taxed, even though they’re paid over time. However, any interest or investment income earned on the settlement money may be taxable depending on how the structure is set up.

Why the Allocation of the Settlement Matters

The IRS doesn’t just look at the total settlement amount—they look at what each part is for. That’s why how your settlement is worded and allocated in the agreement matters.

If your settlement lumps everything together, it’s harder to defend which parts should be tax-free. If your agreement clearly states that specific amounts are for physical injuries or medical costs, it helps protect you in case of an audit.

This is one reason why having an experienced personal injury attorney is essential—they can negotiate and structure your settlement to minimize tax exposure.

How a Lawyer Can Help You Avoid Tax Surprises

Your attorney can do more than just fight for maximum compensation—they can also help you understand how to structure the settlement in a way that makes sense for your financial future.

For example, they may:

• Clearly allocate parts of the settlement to medical expenses or physical injuries
• Separate out any punitive damages or interest
• Help you coordinate with a tax professional if needed

Talk to both your personal injury attorney and a tax advisor before you spend your settlement money. That way, you’ll know exactly what to expect and can plan accordingly.