Whenever a car insurance company approves an insurance claim you receive a settlement equal to the repair cost on your vehicle. Vehicle repairs can be very expensive, and settlement checks from an insurance company can equal very large sums of money because of it. With so much money coming in, it’s important to know how that money is viewed by the IRS and whether you will owe taxes on any of it.

Income tax takes a percentage of your income and gives it to the government, where the money is redistributed among government programs such as schools or the military. Everyone in the country pays income tax; people who make more money each year pay a proportionately higher amount of income tax. In addition to regular salaries and wages, other types of income can be included within taxes; for example, lottery winnings are taxed, as are garage sale profits.

Not all money you receive is automatically taxable!

In the case of insurance settlements, the money that you receive is not considered income. Rather, it is a reimbursement toward the value of something you already own that was damaged. Because you are simply being reimbursed for damage, you are not making a profit on the claim: You are receiving the exact value that was lost, and nothing more.

If your vehicle is involved in an accident, the auto insurance company pays for the cost of repairs up to the replacement value of the vehicle. If your vehicle is a total loss, you are paid for the value of the vehicle and that car will be taken to a stock yard. You can choose to retain the vehicle, but you must buy it back from the insurance company at its salvage price. In other words, you will not receive a settlement for more than your vehicle is worth. Because there is no profit made, the settlement does not count as income.

Sometimes you may also be able to recover diminished value on your vehicle. This is a settlement amount that goes toward value lost on a new car due to an accident. Whenever a car is involved in a collision, it loses value even if the car is repaired completely; the fact that the car was in an accident will be available on reports like Carfax, and buyers would not pay as much if the vehicle was re-sold. Diminished value claims reimburse the difference in value. Since you are being reimbursed for the value of your own vehicle, this should not be considered as income.

Additionally, insurance claims can pay for medical expenses. These become more complicated than simple damage claims, but in most cases basic medical claims will also not be subject to income tax. If your insurance company pays for your actual medical expenses, such as emergency room visits or pharmaceuticals, then you do not make a profit on the accident.

Are car insurance settlements ever taxed?

One situation which may cause your insurance settlement to be subject to income tax is if there are any payments made above the value of your vehicle or the exact cost of your medical claim. If any payment made on the claim could be considered to be a profit, that amount may be taxable. For example, if you are paid for pain and suffering or lost wages, you may be taxed for that portion of the claim. Since you are receiving money above the actual cost of the damage, that money might be considered as income.

Tax laws can be very confusing and sometimes have a number of variables. The best way to determine if your claim payment will be taxable income is to ask a tax professional or accountant. Based upon the specific situation you describe, he or she will be able to tell you exactly what the IRS is owed.

To be safe, you should always save all important documentation from your claims, including records of payments and any out-of-pocket expenses. Not only could these documents prove useful for your tax preparer, they are also important documentation of your claim and could be necessary if there are any concerns with your repairs. Keeping track of your claim settlement payments is a responsible step that will make it much simpler to handle any possible problems that might come up along the way.