Are Car Insurance Settlements Taxable?

Car insurance claims and settlements involve a lot of money. From expensive repairs to medical bills and compensation for lost wages, money is involved in every step of an auto insurance claim. But as with everything related to money, what about taxes?

The compensation you receive from an insurance claim can be very high depending on the damage, injuries, or accident. So do you have to pay taxes for the compensation? Are car insurance settlements taxable?

As with every other thing associated with car insurance, the answer to this question is very complicated. Car insurance can be both taxable and non-taxable, depending on the type of compensation and structure around it.

Let’s look at the answer in detail and find out which policy settlement will let you keep the entire compensation amount and which policies would require you to pay taxes.

1. Understanding Tax on Insurance Settlement

Here’s the simplest way of putting it; the IRS requires individuals to pay taxes on the money they receive that makes them wealthier. There are tax slabs from which people with different incomes come. People who make more every year pay more in taxes.

So not every form of income is taxable. Similarly, not every source of money you get will be taxed. This is applicable to car insurance settlements also. The money you receive for claiming your insurance needed for medical treatments, car repairs, etc., is not taxable.

But then there are some policies that require you to pay taxes for the compensation. Auto insurance policies that compensate for lost wages, mental trauma, etc., are taxable. You’ll have to pay tax for the money you receive from these settlements.

But why do some policy settlements are taxable while others are not? This all comes to the fact that some sources of income make you wealthier, while some are just compensation. Let us get into it in detail.

2. Compensation vs. Income

The income you earn from working or the profits from your business is what makes you wealthier. This is why your payment becomes taxable once it crosses the threshold. The same applies to companies. Businesses pay taxes on their profits and not revenue.

The same can be applied to car insurance settlements. The money that you receive in insurance settlements does not make you richer or add to your wealth. Instead, it just makes up for the loss of money or assets you already had.

Here’s an example to understand it very quickly. Suppose you are driving a car that you bought for $10,000 a few years ago. This is the amount you already paid from the taxable money. Now, let’s say that your car gets stolen, and you have a comprehensive policy to reimburse you for this loss.

The comprehensive policy will not pay you the entire $10,000 but the current market value or the actual cash value of the car. This is the amount of money you would get if you sold the car today. So the money you are getting from the policy settlement is not adding to your wealth. It is just replacing the value of the vehicle.

This is why car insurance policies, such as collision insurance, etc., come with non-taxable settlements. The same applies to payment for medical treatments. You get the money to restore you to your normal self. It is not income; it is just compensation.

3. Taxable Insurance Settlements

Not all policies are exempted from taxes. For example, a personal injury protection plan covers the cost of medical treatments required after a car accident. It also covers any lost wages due to the accident. And the compensation from this policy is taxable.

The component of personal injury protection that compensates for lost wages is taxable, and one can understand why. This policy covers the wages you lost due to the accident. Had there been no accident, you would be working just fine, earning your income. And your income is taxable.

There’s one more where you’ll have to pay taxes for the compensation. If you claim your car insurance for the mental trauma due to the accident, the money you receive will be taxable. Only the compensation for physical injuries is exempted from tax.

4. Saving on Car Insurance

Car insurance is expensive but very important at the same time. Not just that, but almost every state has made it mandatory to have liability insurance. Add personal injury protection, uninsured motorist coverage, collision, and comprehensive insurance to the list, and you’ll have to spend a fortune to insure your car.

Since the cost piles up, it is very important to do everything that helps in saving money. The most important thing you can do in this case is to choose the right car insurance company that offers great coverage at the most affordable price.

Compare all the options you have by finding the most popular car insurance companies in your state. For example, if you reside in, say, Nevada, then find all the best car insurance companies by looking up cheap Nevada car insurance and selecting the best option for your needs.