Are Car Accident Settlements Taxable in Texas?

Will Your Settlement or Award be Taxed Federally or in Texas?

One of the most common questions that comes up immediately upon coming into a windfall of additional cash is “How is this going to impact my taxes for this year?” Injury settlements can be tens or hundreds of thousands of dollars, and more in the case of serious injuries.

Some good news: Texas does not charge state income tax for individuals. That removes a degree of complexity. The vast majority of tax issues for car accident settlements come from federal rules.

However, a settlement is not taxed the same way across the board. The IRS looks at what each payment in a settlement replaces, and that makes determining tax exemption and eligibility a more complex question.

What Isn’t Taxable?

According to the IRS, most compensatory damages for personal physical injuries or physical sickness are usually not taxable at the federal level. This often includes medical costs, pain and suffering, and emotional distress tied to your physical injuries.

Compensation for the following is generally exempt from being considered taxable income at the federal level:

• Compensation for medical care tied to the injuries, as long as you did not previously deduct those same expenses on a tax return
• Pain and suffering tied to physical injuries
• Emotional distress tied to physical injuries
• Compensation for the damaged vehicle up to your financial loss in the vehicle

With that being said, some aspects of these forms of compensation could be taxable depending on whether you took the standard or an itemized deduction on your taxes for a particular year, and whether or not you wrote off your losses from the incident in a previous tax year. We strongly recommend talking to a tax expert about your situation if there is any uncertainty.

What Is Taxable?

Some elements of a personal injury settlement typically are taxable. While these situations or awards are not always present and some are downright rare, it’s important to anticipate any tax burden that may emerge from any of these:

• Punitive damages
• Interest paid on top of the settlement amount
• Reimbursement for medical expenses you deducted in a prior year, to the extent the deduction reduced your taxes
• Emotional distress payments that are not connected to a physical injury
• Amounts paid to resolve non-injury claims folded into the same settlement, such as contract or business disputes

You can find more information on any of these potentially taxable elements on the IRS’s website. If any of these items apply, talk to a tax advisor about your potential liability and plan ahead for an increased tax burden.

Steps That Reduce Tax Surprises

Use the steps below before signing any settlement agreement, and again at tax time to reduce the risk of a surprise bill.

• Ask for a written settlement allocation that separates injury compensation, wage loss, punitive damages, interest, and property damage.
• Gather proof of the injury link, including medical records, billing ledgers, and payment receipts.
• Review prior tax returns for medical deductions related to the crash so you can identify any reimbursement that may become taxable.
• Keep the full settlement packet, including the release, the settlement statement, and any correspondence that explains what each category is paying for.
• Watch for tax forms such as a 1099, especially when there is interest or punitive damages.

Get Your Settlement Terms Reviewed Before You Sign

If your settlement paperwork mixes taxable and non-taxable compensation categories, small wording changes can affect what you are able to keep after taxes. Angel Reyes & Associates can review your settlement terms, push for clear allocations, and protect the value of your recovery. With over 30 years of experience, we have helped more than 70,000 injured Texans get the relief they need after an accident. Contact us today for more information about your options.