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If you have been injured in an accident and are looking to collect compensation for your losses, you might wonder whether you will have to pay personal income tax on your settlement. Fortunately, the answer is typically ‘no’ since the personal income tax law exempts compensation for personal or material damages suffered. According to federal tax law, the compensation received for the damages suffered in traffic accidents and in favor of the injured will be exempt from taxing up to the amount legally or judicially established.

Let’s look at two different scenarios:

  • Compensation obtained by friendly or extrajudicial agreement: In this case, the compensation will be exempt from taxation as long as it is not exceeding the amount legally established. In practice, this almost always happens. If the compensation is higher than the one legally established, only the part that exceeds these limits will be taxed. We must declare this excess as capital gain not derived from the transfer of assets, integrating this amount into the general tax base and will be taxed according to the tax scale.
  • Compensation established by the court: In this case, the entire compensation, whether or not it exceeds the amount legally established, will be exempt from taxation. It is not necessary that there has been a sentence, cases in which there has been a minimum judicial action (search, resignation, judicial transaction, etc.) will be considered equally exempt from tax in the income statement.

This exemption is due to the fact that the reason for compensation a victim of a traffic accident is to make the victim whole after damage suffered. The compensation is not meant to enrich the victim beyond that point.

Despite this we must take into account a few important factors:

  • In the event that compensation for the accident is replaced by a life annuity or a temporary income, the income must be paid as income from work.
  • The part of the compensation obtained for late payment interest will be taxed.
  • The fees of the lawyers in charge of claiming your compensation cannot be deducted.
  • If the compensation is collected by the heirs of the injured party, they must declare it as inheritance tax.

In regard to compensation related to material damages, often covered by the insurance companies, the difference between the amount received and the proportional part of the acquisition value corresponding to the damage suffered is classified as equity gain. In fact, it is unlikely that the amount of compensation received by the victim will exceed the value of the actual damages, so in practice, these benefits have no tax implications for the insured.

How to Ensure Maximum Compensation

Any kind of personal injury due to a car accident is an agonizing life event. With time you may recover, but you will still incur expenses and loses. If the other driver is responsible for the accident, you may be able to file a lawsuit to recover damages. You will have to show that the other driver was responsible for the accident and that you have suffered injuries due to that negligence. If you are in the process of obtaining compensation for your injuries and have questions about settlement financing, contact Capital Financing today to schedule a consultation.