Is My Car Accident Settlement Taxable?

If you’ve been injured in a car accident and have recently settled or are close to settling your claim, it’s natural to have questions about how this influx of funds might impact your finances. One of many people's first worries is: “Will I owe taxes on my car accident settlement?”

It’s completely understandable to be concerned. When you’ve worked hard to recover physically and emotionally after an accident, and you’ve gone through the stress and patience required to reach a settlement, the last thing you want is to be caught off guard by a surprise tax bill. The truth is that the taxation of settlement money can be complicated. It can depend on a variety of factors, including the nature of the damages you’re being paid for, state and federal tax laws, and even how the settlement is worded.

The Different Types of Damages in a Car Accident Settlement

When you settle a car accident claim, the amount you receive often isn’t just one lump sum for “injuries.” It may be broken down (either explicitly in the settlement documentation or implicitly by law) into various categories. Each category can have its own tax considerations. Common types of damages include:

• Compensation for Medical Expenses: These payments cover the cost of your past and future medical care related to the accident, including doctor’s visits, surgeries, rehabilitation, medications, and any other necessary treatments.

• Pain and Suffering Damages: These damages are intended to compensate you for the physical pain and emotional distress you suffered from the accident. They are sometimes called “non-economic damages” because they aren’t tied directly to a specific economic loss like a medical bill but rather the human toll of the injury.

• Lost Income and Lost Earning Capacity: If your injuries forced you to miss work, you may receive damages that cover the wages you lost during recovery. If your injuries are severe enough to reduce your ability to earn a living going forward, the settlement might also address future lost earning capacity.

• Property Damage: This includes compensation for damage to your vehicle or other property impacted by the crash.

• No-Fault Benefits (Personal Injury Protection or PIP) in Michigan: In Michigan, which has a no-fault insurance system, your own insurance company may pay for certain benefits like medical expenses, lost wages, and other necessary services. Settlements might involve unpaid or disputed PIP benefits.


• Attendant Care and Replacement Services: If you require help with daily activities at home—anything from dressing and bathing to housekeeping and yard work—damages might be paid to cover these types of services.

Each type of damage has its own potential tax implications. Understanding which portions of your settlement fall into each category can help you determine your ultimate tax responsibility.

These rules can hold true whether your case settles out of court or you receive a jury award at trial. Of course, there are some caveats and exceptions, which we’ll discuss below.

Medical Expense Damages

Settlement payments covering medical bills related to accident injuries are generally not taxable. However, be cautious if you deduct any of these medical expenses from a previous tax return. If you’ve already received a tax benefit for these costs, you might need to adjust for that benefit later. For example, if you wrote off substantial medical costs on your taxes in a prior year and then received a settlement that reimbursed you for those same expenses, you may need to “recapture” that deduction—basically, pay back the tax benefit you received. Consult a tax professional if this applies to you.

Pain and Suffering

Money received specifically for the physical pain and mental anguish caused by your injuries is generally tax-free under federal law. The logic is straightforward: these damages are meant to compensate you for a real, tangible loss—your health, comfort, and emotional well-being—not provide you with new income.

However, a note of caution: if your settlement agreement includes a confidentiality clause or is structured in a way that isn’t clearly tied to your physical injuries, there could be complications. Occasionally, certain settlement terms can trigger taxes if they make it appear as though the payment is not strictly compensatory for a personal injury. Always ensure that the settlement documents clearly identify the payment as compensation for your injury-related losses.

Lost Wages or Income

While personal injury damages are generally tax-free, lost wages or lost earnings can be a bit trickier. In many states and under federal law, the portion of your settlement that replaces what you would have earned if you hadn’t been injured might, in some scenarios, be considered taxable. 

However, in Michigan’s no-fault system, wage loss benefits are typically treated differently. Under Michigan’s no-fault insurance law, your wage loss benefits are paid at 85% of your lost income, presuming a 15% reduction to account for the fact that these payments are not taxable. In other words, your no-fault wage loss payments themselves are not considered taxable income, so the insurance company automatically reduces the benefit by 15%. The idea is that 85% of your wage is roughly equivalent to what you would have taken home after taxes. 

This arrangement simplifies tax treatment for wage loss under Michigan’s no-fault system. In most cases, the wage loss portion of your car accident settlement in Michigan is not taxable—because it’s already been “tax-adjusted.”

There is, however, an important exception: if you receive “excess” wage loss damages from a claim against the at-fault driver (third-party tort claim) extending beyond the three-year limit placed on no-fault wage benefits, this portion could be considered taxable. Similarly, if you are a very high earner whose lost income exceeds Michigan’s monthly no-fault wage limit, the excess might be taxable. This is because once you step outside the boundaries of no-fault benefits into the realm of a third-party claim for future or excess losses, you’re no longer just receiving a tax-adjusted benefit.

Property Damage

Money that compensates you for property damage (like repairs to your car) is generally not taxable. These funds are meant to restore your property to its pre-accident state. Since you’re not coming out ahead financially but merely being “made whole,” it’s not considered income.

Payments for Attendant Care and Replacement Services

After a severe injury, you might require help with personal care activities (known as attendant care) or with tasks around the house that you cannot do due to your injuries (replacement services). In Michigan’s no-fault system, these services are covered benefits provided by your own insurance company.

The tax treatment of these payments can get more complicated. It’s crucial to distinguish between the injured person receiving funds versus a family member or third party who is providing these services. If you, as the injured person, receive funds for attendant care services that you then pay out to a caregiver or family member, you might not be taxed on those funds yourself. However, the caregiver—whether a family member or a professional—may be required to report that income on their taxes since they’re receiving payment for providing a service. It’s often considered taxable income to the provider.

For replacement services, which cover the cost of tasks like lawn care, cleaning, or running errands, the same logic applies: the person performing the service typically must report that payment as income. Whether these payments are made directly to the provider or to the injured person, ultimately, the provider of the service is receiving income for work done, and that is usually taxable.

If you’re uncertain, it’s best to consult with a tax professional to ensure you correctly handle these types of payments.

Emotional Distress and “Non-Physical” Injuries

Emotional distress damages can sometimes blur the lines. If your emotional distress is directly linked to a physical injury, then these damages are generally not taxable. But if the emotional distress is unrelated to physical injuries—for example, if it stems from harassment, defamation, or discrimination—then the IRS might consider those damages taxable.

In a car accident context, emotional distress is usually tied closely to the physical injuries sustained. Sleepless nights, anxiety, and depression that arise because of physical pain and trauma are typically considered part of your personal injury damages and remain tax-free. Just be sure your settlement clearly states that the emotional distress is related to your physical injuries.

Confidentiality Clauses and Other Special Situations

Sometimes, defendants will request that a settlement remain confidential. While this may not be common in a straightforward car accident case, it’s not unheard of. In some instances, adding a confidentiality clause might transform some or all of the settlement into taxable income. Courts have found that if a portion of the settlement is paid specifically in exchange for confidentiality, that portion might be considered taxable. 

If this situation arises, talk to your attorney to understand the implications. You may need to weigh the financial downsides of confidentiality against any personal reasons you might have for keeping the agreement private.

Working with Tax Professionals and Attorneys

If you have any doubts about the tax implications of your settlement, consider consulting a Certified Public Accountant (CPA), an enrolled agent, or a tax attorney. They’ll help you identify which parts of your settlement might be taxable, ensure you report everything correctly, and advise you on any deductions or credits you might be entitled to.

For example, if your settlement includes reimbursement for medical bills that you wrote off in a previous tax year, a tax professional can help you figure out if you owe any taxes as a result. If your settlement includes both taxable and non-taxable components, they can guide you in how to accurately report them. Working with a tax expert is the best way to ensure that you don’t overpay or underpay your taxes.

Keep in mind that most personal injury attorneys are not tax experts. While they can provide general guidance based on their experience, the best strategy is often to involve a qualified tax professional if you have complicated financial circumstances or if the settlement terms are complex.

When in Doubt, Ask for Help

It’s normal to still have questions. Every case is different, and tax issues often depend on small details that might not be obvious if you’re not trained in tax law. Don’t hesitate to seek professional guidance. A conversation with a CPA or a tax attorney can clarify things in a way that no article ever could.

Moreover, don’t hesitate to reach out to an experienced personal injury attorney as you settle your claim. A good attorney understands the basics of tax implications and can guide you to appropriate resources. They can help ensure your settlement agreement is written in a way that clearly reflects the nature of the damages, minimizing any chance of confusion come tax time.

Contact Us for More Information

If you have concerns about your car accident settlement, need help understanding how the tax rules might apply to your unique situation, or want guidance before accepting a settlement offer, we’re here for you. At Goodman Acker P.C., our compassionate and experienced personal injury lawyer are dedicated to helping accident victims throughout Michigan. 

We work tirelessly to ensure you receive the compensation you deserve and help you understand every aspect of the process—including what happens after the settlement. Contact us today at (248) 831-1507 or through our online form for a free consultation. We’re available 24/7 to answer your questions and support you on your journey to recovery.