Q. I’m expecting to receive a settlement from an auto accident. How would those funds be taxed?
A. We hope you weren’t injured in the accident and that this settlement will make you whole.
There are five different types of settlements as a result of an auto accident:
1. Reimbursement for physical damages to your car;
2. Reimbursement for lost wages;
3. Medical reimbursement for bodily injury to yourself;
4. Reimbursements for pain and suffering due to your physical injuries; and
5. Punitive damages.
If your car is damaged in an accident and you receive compensation for those damages, that payment is not income for tax purposes, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
He said it doesn’t matter whether the payment was from insurance or from the person who damaged your car.
“This type of payment is called an indemnification,” he said. “When you are indemnified, you are not better off. Instead, you are put back to the same position you were in before the accident.”
Reimbursements for lost wages is not an example of indemnification, he said. If you worked and received a paycheck, you would have paid income tax on it. So if you are awarded lost pay, you would be required to pay income tax on the award, he said.
Section 104 of the Internal Revenue code specifically excludes from income “the amount of any damages (other than punitive damages) received (whether by suitor agreement and whether as lump sum or as periodic payments) on account of personal physical injuries or physical sickness.”
That means all the payments for your physical injuries are tax-exempt, Kiely said.
Payments for pain and suffering can get complicated.
“If your pain and suffering is the result of a physical injury, your award is not taxable,” he said. “However, if your pain and suffering is classified as emotional distress, it is taxable.”
Finally, punitive damages — which are intended to punish the offender — are always taxable, Kiely said.
Email your questions to Ask@NJMoneyHelp.com.
Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.