If you are in the process of negotiating an insurance settlement, you expect to receive compensation for a car accident, slip and fall, or another type of personal injury.
One important question is whether the settlement funds you expect to receive are taxable.
In Nevada, the answer is complex. Some types of compensation from an insurance settlement are taxable – other types are not. Knowing what is subject to tax can help you when negotiating your settlement and as you plan for the future.
Is an Insurance Settlement Taxable in Nevada?
Whether an insurance settlement is taxable depends on what the settlement compensates. There is no tax on compensation for medical care, property damage, or pain and suffering. The funds are taxed if there is compensation for lost income or punitive damages.
How do I know whether an insurance settlement is subject to tax?
Whether an insurance settlement – or part of an insurance settlement – is subject to tax depends on what it is replacing.
Compensating you for a loss
Some insurance settlement funds compensate you for direct, out-of-pocket losses. For example, a medical bill is a loss that you have to pay. It wouldn’t make sense to tax you on that amount because the funds are replacing a direct, out-of-pocket loss. Property damages fall into the same category. You already paid taxes on the funds you used to acquire the property in the first place.
Replacing income or punitive damages
Other losses either replace income or are funds that do not compensate you for a direct loss. An example is settlement funds based on loss of earned income being subject to tax if you had earned the funds through work. Therefore, the amounts are subject to tax as an insurance settlement. In addition, punitive damages awards are subject to tax.
Types of an Insurance Settlement that are Taxed
If an insurance settlement or a court award falls into the following categories, they are taxable:
- Lost income
- Lost business profits
- Interest on any judgment
- Punitive damages, even if from a physical injury
What about emotional distress damages – are they taxed as part of an insurance settlement?
Most insurance settlements are related to injury accidents. When it comes to settlements and judgments, IRS tax laws distinguish between two types of emotional distress damages.
First, there are emotional damages relating to a physical injury or sickness. If you’re in a car accident – you have physical injuries and, along with them, emotional anguish. These types of emotional damages are not taxed. They’re seen as an extension of the physical injury, so they are not taxed.
Second, there are emotional damages that result from other situations – like unlawful discrimination or libel and slander. Emotional distress damages from harm other than a physical injury or sickness are subject to tax.
Source: IRS Publication 525 (2021), Taxable and Nontaxable Income
Note: If you receive a settlement for medical expenses that were deducted in prior years, you must report the portion of funds that provided a tax benefit. It should be reported as “Other Income” on Form 1040, Schedule 1, line 8z.
Are property damage insurance settlements taxed in Nevada?
No. Property damage insurance settlements are not taxed in Nevada. You already paid taxes on the funds you used to purchase the property. It would be an unfair penalty to tax the funds that compensate you for your loss. If the funds were taxed, you would no longer be made whole for what you lost.
Are punitive damages from an insurance settlement taxed?
Punitive damages from an insurance settlement are taxed. They must be reported as “Other income.” Even if the punitive damages stem from a personal injury accident, they are not compensating the victim for a specific loss. Instead, the damages are awarded to punish egregious conduct on the part of the defendant. For this reason, punitive damages from an insurance settlement are subject to tax.
Are insurance settlements taxed as income by the State of Nevada?
There is no income tax in Nevada. The state levies no personal or corporate income taxes. Nevada residents pay other types of taxes, including sales and property tax. Therefore, an insurance settlement is not subject to additional taxes beyond what may be subject to federal tax.
How Do I Pay the Least Amount of Taxes on My Insurance Settlement?
You have some control over how much you pay in taxes on an insurance settlement. As you negotiate your settlement, you can structure it to compensate for your non-taxable damages.
Of course, how you structure the insurance settlement needs to be truthful. Be sure that your settlement accurately reflects your losses in the way that is most advantageous for your interests, including tax consequences.
Another way that you can structure your settlement to reduce taxes is to structure it over a period of time. For example, you may receive $50,000 in compensation for lost income. If you accept those funds all at once, you may be in a higher tax bracket for that year. However, if you spread the compensation out to $10,000 per year for five years, you may not move into higher tax brackets. Over time, the reduction in taxes may be significant.
Understanding Insurance Settlement Taxes in Nevada
If you’re pursuing an insurance settlement in Nevada, know that the funds may be taxed. Most notably, replacement income compensation is subject to tax. However, compensation for direct losses are not taxed. These considerations are important to keep in mind as you go through the process of pursuing your settlement.
Many things may impact your best interests when pursuing an insurance settlement. Our attorneys at Nevada Accident Injury Lawyers have experience helping clients protect their best interests. We can evaluate all the factors that may be important in your case and pursue a personalized plan designed for you. We also explain the law and what you need to do to maximize your settlement funds.
Contact us today for a discussion of your case.