If you win a lot of money in a settlement for a car accident, it can change your financial situation enough that you start to worry about taxes. Typically, any money you get, the government will tax.
When it comes to settlements, there are some confusing rules. The IRS explains it will depend on what you receive the settlement for as to how taxation works.
Punitive damages
Punitive damages are those the court awards to punish the other person. These do not replace any loss you had due to the accident. The IRS considers this income and therefore they are taxable.
Emotional strain
The part of your settlement paid for emotional or mental stress resulting from a physical injury is not taxable. However, if you receive such payment for stress not related to an injury, it is taxable.
Lost wages
Payments for lost wages are taxable. You will have to pay your portion of Medicare and Social Security taxes on it. You must claim it as wages.
Physical injury
Any part of your settlement paid for injury compensation is not taxable. The exception is if it reimburses you for medical expenses for which you itemized deductions on your taxes previously. In that case, it is taxable.
Property value
You may get money for the loss of value of an asset lost in the accident. This type of payment is not taxable. However, if the amount you get is more than the actual value of the item, then the excess part is taxable.
Because the taxes on a settlement are so complex and confusing, it is probably a good idea to have a financial professional assist you with filing your taxes once you receive your money.