Car accident settlements are generally not taxable in Texas.
The Internal Revenue Code Section 104(a)(a)(2) excludes from gross income money received in a settlement paid “on account of personal physical injuries or sickness.” Section 104 does not apply to punitive damage awards. The settlement received must be on account of personal injuries or sickness to qualify meaning that generally any settlement money you receive for medical bills, disfigurement, physical impairment, pain and suffering and the like are not taxable.
While damages on account of physical injuries are not taxable, emotional distress damages and damages that arise from emotional distress are taxable. For instance, if settlement money is paid on account of a client’s insomnia or fear of driving, then those items of damages would be taxable. Settlement money paid on account of lost earnings or lost earning capacity are taxable. Also, the IRS may tax a portion of your settlement that constitutes payment for confidentiality.
While there is no surefire way to insure that a portion of your personal injury settlement will not be taxed by the IRS, there are things that we do to reduce the risk that any portion of our clients’ car accidents settlements are taxed. First, we include a provision in the settlement agreement stating that the settlement is only paid on account of personal physical injuries or sickness. Second, if the defense requests confidentiality, we add a clause in the settlement agreement that states that no additional money was paid in the settlement for the confidentiality or we assign a very low consideration, say $100, for confidentiality.
In the vast majority of car accident claims that we handle, the entire settlement is solely awarded only on account of personal physical injuries so that there is no tax consequences. If there is a very significant claim for lost earnings and a large settlement, there are steps that we can take to minimize the risk that the IRS will tax the settlement. In my 16 years of practice, I have never had a client tell me that any part of their personal injury settlement was taxed by the IRS, from the small fender bender settlements to the large 7 figure awards that our clients have received.
Our job as your personal injury lawyer is to get you the best settlement possible and to reduce the risk that the IRS will tax a portion of your settlement. With that said, we are not tax lawyers and we do not make any guarantees regarding the tax consequences of a settlement. I hope this helps answer your questions regarding the taxability of your car accident settlement and please give me a call if you have any questions.