Insurance Refunds: Taxable Income Or Not?

Whether or not insurance refunds are considered income depends on the type of insurance and the nature of the refund.

In general, if you're paying premiums yourself, such as for homeowners insurance and auto insurance, then your insurance benefits are not a taxable event. Your benefits are reimbursement for expenses, rather than income.

However, there are times when an insurance payout or policy will attract the attention of the Internal Revenue Service or state tax authorities. For example, if you deduct part of the cost of your car as a business expense, the insurance benefit might be considered a gain. You are only taxed on the benefit if the insurance reimbursement is above the amount of your tax deduction for the use of your car.

Death benefits on an individual’s life insurance policy are not considered taxable income. However, depending on the amount of the life insurance policy, how it is owned and the state where the deceased person lived, you (the beneficiary) could have to pay estate taxes on a life insurance policy.

Federal estate taxes must be paid on life insurance benefits above $5.25 million in 2013, but only if the policy was owned by the deceased individual. If a life insurance policy is owned by the beneficiaries, they won’t have to pay an estate tax.

The minimum benefit subject to state estate taxes varies. For example, in Maryland, life insurance benefits of more than $1 million are subject to the state’s estate tax.

Dividends and interest on permanent life insurance products are sometimes taxable. Dividends are typically considered a return of the premiums you have paid and are not taxable unless you previously deducted the premiums from your taxes. Interest that accrues on a cash value life insurance policy will be considered taxable income, and you should receive a Form 1099 showing the total interest earned each year.

Whether disability insurance benefits are taxable depends on how you paid your premiums. If you pay your premiums with pretax income, then the benefits are considered taxable income. If you pay the premiums with after-tax dollars, then the benefits are tax-free.

Long-term care insurance benefits are typically tax-free. However, some people can deduct a portion of their long-term care insurance premiums from their taxes. Your benefits could be taxed if they exceed your medical expenses.

As long as you have a doctor attest to your need for care, some insurance policies will pay your benefits even if you are being cared for at home by a family member rather than incurring expenses in a nursing home. In that case, since you wouldn’t actually have reimbursable medical expenses, your benefits would be considered taxable income.

Property insurance claims

Money received from property insurance claims is typically not taxed. The Internal Revenue Service (IRS) does not consider insurance claim payouts as income, but rather as compensation for losses incurred. This means that you do not need to report property insurance payouts on your tax return.

However, there are some exceptions to this rule. If your property damage settlement includes compensation for emotional distress or punitive damages, these portions of the settlement may be subject to taxation.

Additionally, if you receive insurance proceeds that exceed the actual cost of repairs or property replacement, the excess amount may be taxable as it could be considered a taxable gain or income. Therefore, it is important to maintain accurate records of your property restoration expenses to avoid being taxed on the money received.

Furthermore, if you claimed a casualty loss deduction for the property in a previous tax year and then received an insurance reimbursement, that amount may also be taxable.

Other Types of Insurance Claims

While property insurance claims are generally not taxed, there are other types of insurance claims that may be taxable. These include:

• Life insurance claims: Life insurance payouts are typically not taxed. However, if the policy was transferred for cash or other valuable consideration, there may be tax implications. Additionally, any interest gained from a life insurance payout or withdrawals from a cash-value life insurance policy may be taxable.
• Disability insurance claims: Whether disability insurance benefits are taxable depends on how the premiums were paid. If premiums were paid with pre-tax income, the benefits are typically taxable. If premiums were paid with after-tax dollars, the benefits are usually tax-free.
• Medical claims: Medical claims, whether part of a settlement or reimbursement for expenses, are generally not taxed.
• Lawsuit proceeds: Compensation for medical bills and property repair resulting from a lawsuit is typically not taxed. However, punitive damages and payouts for pain and suffering may be taxable.

Medical claims

The IRS allows you to deduct unreimbursed payments for:

• Preventative care
• Treatment
• Surgeries
• Dental and vision care
• Visits to psychologists and psychiatrists
• Prescription medications
• Appliances such as glasses, contacts, false teeth and hearing aids
• Expenses that you pay to travel for qualified medical care

At this time, all unreimbursed medical expenses incurred as a result of COVID-19 are tax-deductible.

If you pay for your medical expenses using money from a flexible spending account or health savings account, those expenses aren't deductible because the money in those accounts is already tax-advantaged.

Life and disability insurance claims

• Life Insurance Proceeds: If you receive life insurance proceeds as a beneficiary due to the death of the insured person, these proceeds are generally not included in your gross income and you don't need to report them. However, any interest earned on the proceeds is taxable and should be reported. If the policy was transferred to you for cash or other valuable consideration, the exclusion for proceeds may be limited, and you may need to report a taxable amount.
• Disability Insurance Benefits: Whether disability insurance benefits are taxable depends on how the premiums were paid. If you pay the premiums with pre-tax income, the benefits are typically considered taxable income. On the other hand, if you pay the premiums with after-tax dollars, the benefits are usually tax-free. If your employer pays for the disability insurance plan, you must report any benefits received as income. If both you and your employer contribute to the plan, only the portion attributable to your employer's payments is taxable.
• Waiver of Premiums for Total Disability: If you have a disability insurance policy that includes a waiver of premiums due to total disability, the waived premiums are generally not considered taxable income. However, if you receive disability benefits in addition to the waived premiums, those benefits may be taxable.
• Accelerated Death Benefits: If you receive accelerated death benefits under a life insurance policy because the insured person is terminally or chronically ill, these benefits are typically excluded from taxable income. This exclusion applies as long as the benefits are based on qualified long-term care services or actual expenses incurred.
• Refunds and Reimbursements: If you receive a refund or reimbursement for insurance premiums or expenses that you previously deducted on your tax return, the refund may be considered taxable income. This depends on factors such as whether you itemized deductions, the type of insurance, and the specific circumstances of the reimbursement.
• Interest Income: Any interest income earned on life insurance proceeds or disability insurance benefits is generally considered taxable and should be reported as interest received.

Lawsuit proceeds

The proceeds from a lawsuit are generally considered income and are taxable under Section 61 of the Internal Revenue Code (IRC). However, there are some exceptions to this rule, as outlined in IRC Section 104.

Physical Injury or Sickness

Under IRC Section 104(a)(2), damages received due to personal physical injuries or physical sickness are excluded from gross income. This includes compensatory damages, such as lost wages, resulting from a personal physical injury. It is important to note that punitive damages are not excluded and are generally taxable.

Emotional Distress

Emotional distress damages that arise from a physical injury or sickness are also considered non-taxable. However, if the emotional distress is not a result of a physical injury, the proceeds may be taxable. The IRS requires proof that the defendant's actions led to physical illness or injury for the settlement to be non-taxable.

Medical Expenses

Lost Wages

Any wages awarded in a lawsuit are generally considered taxable income. Lost wages are taxed as income because they would have been taxed if received without interruption. Additionally, these wages are subject to social security and Medicare taxes.

Interest

Interest accrued on lawsuit proceeds is generally taxable. This includes both pre-judgment and post-judgment interest.

Punitive Damages

Punitive damages are typically awarded to punish the defendant rather than compensate the victim for specific losses. Punitive damages are generally taxable, with a few exceptions. For example, in certain wrongful death cases where punitive damages are the only damages awarded, they may be excluded from gross income.

Repair or replacement of property

If you receive an insurance payout to repair or replace your property, this is generally not considered taxable income. This is because the purpose of insurance is to "make you whole", meaning that you should only receive enough payment to bring you back to the state you were in before an incident occurred. For example, if your car is totalled in an accident and you receive a $10,000 payout to buy a new car, you are in the same place you started. You haven't gained anything, so the IRS won't charge you.

However, if you have extra money left over from your claim after your property has been replaced or repaired, this may be considered taxable income. This could be because the insurance company overpaid you, or because you performed the repair yourself and paid yourself for doing so. If you do have to pay taxes on an insurance claim, you'll receive a 1099 form to help you file.

Other types of insurance claims

Medical claims are not taxed, whether they are part of a settlement you make after an accident or simply a claim for a medical appointment. This is because the money you receive is only reimbursing you for money you previously spent.

Life and disability insurance claims may be taxed, depending on the size of the insured's estate and whether the insured is still alive. Lawsuit proceeds may also be taxed, depending on the type of compensation you receive.

Frequently asked questions