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Are Insurance Settlements Taxable?

Are Insurance Settlements Taxable?

An insurance settlement is the payment received from your insurance company against your claim. This Buzzle article discusses whether insurance settlements are taxable or not.
Buzzle Staff
If you have undergone physical injuries and have received settlements for the same, they are generally not taxable and not reported either, as long as the medical bills are not deducted. If, however, you deduct the medical expenses and still receive settlement for the injury, it is taxable and needs to be reported under "Other Income".
Insurance settlements and claims are always subject to certain conditions and exceptions. Generally, when one is provided an insurance settlement, it is not taxable.
However, it may be subject to taxation based on the type of insurance and certain other circumstances. You should also know when this needs to be reported and when it need not, while filing for taxes. The paragraphs below will explain these terms and conditions in detail.
Auto Insurance
  • It is generally not taxable.
  • The payment received on theft or damage to your car is not subject to taxation.
  • This is especially true if your car is being replaced. However, if you subtract the cost of the car and report it, you will be taxed on the extra benefit you have received.
  • This is because the value of your car has already depreciated, and the insurance payout is considered as extra gain. Thus, if it is more than the amount of tax deducted, your insurance will be taxable.

Life Insurance
  • This is not taxable.
  • However, it could be subject to taxation, and this depends a great deal on the amount held by the policy as well as the residence of the deceased.
  • If the policy was completely owned by the individual himself, it would have been taxable if the amount would have been above USD 5.25 million (as of 2013).
  • If the beneficiaries held the policy, the policy is not taxable until a minimum amount.
  • Also, the amount that is taxable varies from one state to another.

Health Insurance
  • Depending on certain circumstances, a health settlement is taxable.
  • One such situation is when the employer sponsors the insurance for his employee and his family.
  • This is taxable under the federal law, and the worker must pay tax to his employee on the costs that the company has covered for his partner.
  • The tax can be paid even by deducting a part of the worker's salary.
  • If, however, the worker's partner qualifies as his dependent, the insurance settlement is not taxable.

Disability Insurance
  • This is taxable under certain circumstances.
  • A major condition here is the premium payout.
  • If your premiums are paid with pre-tax income, the settlement is taxable.
  • If the premiums are paid with post-tax income, the settlement is not taxable under the law.
  • Most experts recommend that this policy be purchased with post-tax income so that you do not have to bother about taxes while receiving insurance benefits.
  • Another important reason for this recommendation is that most disability insurances pay less than 75% if you become disabled.

Homeowners Insurance
  • It is generally non-taxable.
  • If your house gets damaged or needs repairs or a replacement, the insurance is not taxable.
  • However, after you are reimbursed for your loss, if you do not use or reinvest the money within the stipulated time, the payout could be considered an additional benefit.
  • Hence, it is vital that the proceeds be used immediately for the concerned purpose or at least invested properly for the same.

Long-term Care Insurance
  • It is taxable under certain conditions.
  • If you deduct some of your premium, your insurance payout may be taxable.
  • Also, if your medical expenses exceed a stipulated amount, the settlements are taxable.
  • To be more specific, if you are being cared for by a doctor in a nursing home, your insurance settlement will not be taxed.
  • If you are being cared for at home by a family member or friend, the insurance proceeds will obviously be taken as extra gains, and will be taxable.
Things to Remember
  • There are certain permanent life insurance policies that earn dividends.
  • These dividends are nothing but a turn-around payout of the premiums that were paid.
  • They are generally not taxable, but if you have deducted the premiums from the taxes earlier, they would be taxable under the law.
  • The interest that is accumulated on a cash value policy is also taxable.
  • If your insurance company offers you the chance to buy additional insurance with the interest accrued, then the interest is not taxable.
  • There are also certain conditions regarding the impact of divorce settlements on your taxes.
  • Whoever receives the alimony has to pay tax, and whoever pays alimony qualifies for a tax deduction.
  • In case of property settlement, if the property is given to one spouse by mutual decision, he/she could pay property settlement to the other. This resolves a lot of complicated legal issues.
  • If you are physically wounded, the compensation awarded to you is not taxable.
  • If, however, you have deducted the medical expenses, the insurance payout is considered an additional benefit and is taxable under the Federal law.
Resolving insurance settlements can be a trying and complicated procedure. Though initially, insurance companies assure that the process will be as smooth as silk, it is not so. There are a number of conditions, rules, and situations to be considered. Therefore, when you are deciding whether your insurance settlements are taxable or not, consult a good lawyer and a trustworthy tax professional, explain the entire situation with intricate details, and then go ahead with filing your claims and taxes. Taking professional advice is always better.