Are Insurance Claim Checks Taxable Income?

Filing your returns can be excruciatingly frustrating. However, proper filing is important to not only evade the wrath of the taxman, but can also help you get one up over the IRS in the form of tax refunds.

Knowing what to declare as income can be a tad confusing, as is the case for insurance claim checks. 

Insurance claim checks are typically not taxable. The goal of insurance claim checks is to compensate you for a loss and return you to your state before an accident, and as such, these benefits do not qualify as income. 

This article will pull the veil away from the usually puzzling insurance claim checks so that you can better understand what they represent and whether you should include them as taxable income in your filing or not. Read on for more. 

Are insurance claim checks subject to taxation?

Insurance claim checks are not taxable. Insurance claim checks aim to compensate you for a loss and return you to where you were financially before the loss. 

As a result, insurance claim checks, as a general rule, are not subject to taxation.  Insurance claim checks are a particularly tricky subject, and if you find yourself racking your brain trying to figure out how they should be treated, it's best to breathe in and realize you are not alone.

Better yet, contrary to common belief, they are pretty straightforward to comprehend.  To understand how to treat insurance claim checks, let us first discuss what is taxable in the United States and what insurance claim checks intend to accomplish. 

Taxable income in the US – Overview

Your taxable income is your gross income, which the taxman will use to calculate how much you owe in tax in a given year. The main items included in your taxable income are salaries, wages, bonuses, investment income, tips, and a plethora of unearned income. 

The common theme in these items is that they represent money earned - income.  The IRS, however, provides several deductions which lower your tax bill. 

However, you need to claim these deductions, and the IRS provides forms to make this easier for you. For instance, if you give a certain amount of money from your income to charity, this amount will be dedicated from your taxable income. 

But what about insurance claim checks? Are they also deductions?

Insurance claim checks

Insurance claim checks represent funds that you will receive as a form of settlement for an insurance claim. Insurance claim settlements are intended to ‘make you whole, and thus are typically not taxed. 

According to this source, the objective of an insurance claim is to restore you to the state you were before an incident. For instance, when this money is issued to cover your medical costs or to repair your automobile, it is typically used to cover these costs, even when it is a substantial sum. 

It is unlikely that an insurance company will overpay you to cover a given loss. In fact, most of the time, this money is not sufficient to cover all of the losses you may have suffered due to the accident.  

While insurance claim checks are typically not taxed, and your insurance company is unlikely to overcompensate you for a loss, there are several special circumstances where your insurance checks will affect your taxable income. 

Let’s look into these below.

How insurance claim checks may affect your taxable income

Like in virtually anything related to money or finance, there are unique situations that deviate from the norm. Insurance claims are no different, and knowing about these aspects can either decrease taxable income or help you avoid penalties.

Overvaluation

Insurance companies are not infallible. After all, many aspects of the valuation of a loss can be subjective, which means that your loss may be overvalued or undervalued. 

In some unique instances, the amount of your claim check may be higher than the value of the loss it seeks to compensate you for. 

For instance, if the amount of loss to your automobile or property is estimated to be $20,000, but this figure is more than the decreased value (say $18,000), this represents a gain.

In this instance, your loss has been overvalued by the amount of the insurance claim check less the loss value. In the above case, you have a net gain of $2,000.

Typically, you should report this figure as a gain.  However, this is extremely rare, and in most cases, the insurance company does a thorough inspection of the loss before issuing a check.

Catching the taxman flat-footed is, therefore, a myth.  Still, if you notice that you have a net gain, do not be too quick to dish the extra cash to the IRS.

Sometimes, the insurance company can award you more, going over and above the reimbursement and including additional awards for special aspects such as emotional suffering and lost wages.

The good news is that awards related to lost wages and special suffering are not taxable. Accordingly, you should consult with your financial advisor or insurance agent about what the additional amount represents, before including it as a net gain and unwittingly giving the taxman a piece of your cake they do not deserve.

Undervaluation

Undervaluation of your loss is often more common than overvaluation. In this case, the insurance company gives you less in terms of compensation than is necessary to cover the loss. 

For instance, if your property has an appraised value of $200,000 before a fire, and this value falls to $50,000 after the fire, then the insurance company should write you a check for $150,000.

However, in most cases, this value is usually less than is necessary to cover all the costs. Taking the above scenario, your insurance company may only issue a claims check of $80,000.

If this happens to you, don’t panic.  In the above example, the $70,000 that you do not receive is eligible for consideration as a tax deduction.

However, note that the IRS will not deduct this entire amount from your taxable income.  As aptly noted on the IRS website, you can only deduct losses that are more than 10% of your gross income.

Additional costs may also apply, including subtracting $100 from the salvage value. 

Conclusion

In closing, insurance claims are generally not taxable. While there are rare instances where the value of the claim check may be greater than the value of the damage, this deviation is often due to included non-taxable awards. 

As a good rule of thumb, always refer to your insurance agent or financial advisor if you are unsure and when you realize that the amount of the insurance claim check is either higher or lower than what is needed to cover the loss.