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Are Insurance Settlements Taxable?

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Insurance Q&A: “Are insurance settlements taxable?”

The answer to this one depends on the type of settlement (also known as damages) you received from the insurance company.

Insurance is designed around the concept of indemnity, or restoring the injured party to its “pre-accident” financial or health position.

There are three types of possible damages to be awarded with regard to a lawsuit. They include personal injury, property and punitive damages. Let’s take a look at each:

Personal Injury Damages

You suffered bodily injury as a result of an accident another individual or entity was found to be at-fault for causing.

If this is the case, you should not have to pay taxes on this type of settlement in accordance with the principle of indemnity. You are not receiving “extra” money in the form of income, rather just getting back to normal, which does not trigger any sort of tax.

Property Damages

Similar to personal injury damages awarded in a lawsuit or insurance settlement, you would not owe any taxes for any property damage incurred.

Again, the principle of indemnity means your property is simply being restored back to the shape it was in prior to an accident. You are not receiving any sort of windfall here, rather getting back to even.

Uncle Sam does not have tax provisions for staying neutral financially, just when you are earning or receiving money in addition to where you currently sit.

Punitive Damages

Insurance companies do not have to pay punitive damages as a result of a lawsuit, as it wouldn’t be “fair.”

Your insurance policy, which is a contract, states the insurer will pay for bodily injury or property damage caused by their insured.

It doesn’t make sense for the insurer to pay for insurance claims for damages awarded to an injured party as a result of the behavior of their insured that is considered purposefully malicious, which is the typical reason punitive damages are awarded.

Since this particular type of damage doesn’t fit the normal category paid by an insurer, any money awarded to you as a punitive damage may be taxable. Ultimately, this is money you would be receiving beyond what would indemnify you back to your pre-accident position.

Note: Insurance companies typically do not pay punitive damages based on language set forth in their policy forms.

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