Most people don’t pay tax on car accident settlements in Michigan. The IRS doesn’t count money you receive as compensation for physical injuries or illnesses as income, so you usually don’t pay tax on it. Michigan uses your federal adjusted gross income to determine how much you owe in state tax, so if the IRS doesn’t tax your settlement, Michigan shouldn’t either. Still, not every part of a car accident settlement is tax-free. Some parts, such as interest payments or compensation for emotional distress without a physical injury, could count as taxable income.
What Types of Settlement Compensation Are Tax-Free?
You won’t owe tax on the parts of your settlement that cover physical injuries or illnesses, including money for medical bills, pain and suffering, and income losses resulting from those injuries. This is because the IRS does not treat compensation for physical injuries or illnesses as income but as reimbursement for the harm you suffered.
More specifically, wage loss is not taxable, because the 15% reduction is an inferred tax bracket paid by the auto carrier to the IRS. In other words, the carrier has already paid the tax. If the insured is in a tax bracket less than 15%, they can appeal that 15% reduction and get it further reduced.
What Portions of a Settlement Might Be Taxable?
Some parts of a settlement count as income that the government will tax—for example, any interest you earn on your settlement money. In the event the other side takes months to pay, you might get extra money to account for that delay, and that payment would count as income. If your settlement includes money for emotional distress not tied to your injury, that would also get taxed. You might also owe tax on lost wages if they aren’t connected to a physical injury. These rules apply at both the state and federal levels.
Additionally, in Michigan, attendant care paid through a PIP policy or excess bodily injury policy is taxable to the person providing the services. An experienced tax professional can give you more information about whether this may apply to you.
Common Tax Mistakes to Avoid Before and After a Settlement
You don’t want to guess at how taxes will apply to your car accident settlement. One small error could lead to extra taxes, penalties, or even an audit. Below are some common mistakes that people make so you know what to avoid:
- Lumping Everything Together: If you don’t clearly break down how much of your settlement covers medical bills, pain, or wages, the IRS might decide for you and tax more than they should.
- Forgetting About Interest: If your settlement includes interest because the other side delayed payment, you have to report that interest as income.
- Not Checking the 1099: You might get a 1099 form for your settlement, even if most of it isn’t taxable. If you don’t review it or report it correctly, the IRS might think you’re hiding income.
- Waiting Too Long to Get Advice: Talking to a lawyer after you sign a settlement agreement makes it harder to fix problems. It’s better to get help before you agree to anything.
How a Lawyer Can Help You Structure Your Settlement for Tax Clarity
A lawyer can walk you through each part of a settlement offer now to help you avoid tax problems later. They can work with the other side to write clear terms that explain how much money from the settlement is meant to cover physical injuries, lost wages, or other losses. This will make it easier to report the money correctly at tax time. Your attorney can also flag any part of your settlement that might trigger a tax bill, like interest payments, and help you plan for it.
Contact a Car Accident Attorney in Michigan
If you have questions about your car accident settlement or want help protecting your money from unnecessary taxes, contact Atnip & Associates, PLLC, today. Our team can review your case and explain your options during a free consultation.
