“Is the settlement I received as a result of my motor vehicle collision taxable?”
A settlement received in connection with your lawsuit for pain and suffering due to injuries sustained in a crash is not taxable. These damages represent compensation to you for physical and emotional pain and suffering incurred because of the collision. The IRS Code has consistently held that compensatory damages received on account of a personal injury are excludable from gross income.
In order for a settlement or award to be excluded from income, it must be based out of an action for “tort or tort type rights,” and “must provide the availability of a broad range of damages, such as damages for emotional distress, pain, and suffering.” A personal injury case arising out of the negligent operation of a motor vehicle satisfies this requirement.
The second requirement is that the damages must be received “on account of personal injuries or sickness.” A leading example by the Supreme Court considered this very issue, where a “taxpayer who is injured in an automobile accident sues for (1) medical expenses, (2) pain, suffering, and emotional distress that cannot be measured with precision, and (3) lost wages.” According to the Court, “the second requirement would be met for recovery of (1) the medical expenses for injuries arising out of the accident, (2) the amounts for pain, suffering and emotional distress, and (3) the lost wages as long as the lost wages resulted from the time in which the taxpayer was out of work due to the injuries sustained in the accident.”
Additionally, Rev. Rul. 85-97, 1985-2 C.B. 50 concludes that the entire amount of a settlement received by a taxpayer who was injured after being hit by a bus was excludable from gross income as “amounts received on account of personal injuries” and therefore not taxable.