It's good news when an insurance payout arrives to cover home repairs, a stolen car or your medical bills. It's less delightful if you spend the money, then discover you have to pay tax on it. The federal tax code treats some insurance payouts -- not all -- as taxable income you must declare.
If you're the beneficiary of a life insurance policy, you don't pay tax on the face value of the policy. If you allow the insurer to hang on to some of the money so that it earns interest, the interest is taxable income. The Internal Revenue Service rules state that if the insurer pays off in monthly installments -- a mix of principal and interest each month -- you total the interest for the year and add that to your taxable income.
With health insurance payouts, it's more complicated. Payouts to cover medical expenses are never taxable, but sickness and injury benefits for lost work time or disability may be. If you pay your own premiums, the benefits are not taxable. If your employer pays the entire premium, the entire benefit is taxable. If your employer pays 70 percent of the premium, 70 percent of the benefits are taxable. Workers' compensation payouts for on-the-job injuries, are not taxable.
Casualty and Theft
If your insurer pays you because your house burned down, you lost your wedding ring or someone stole your car, you don't usually have to worry about taxes. If, however, the payout is more than the adjusted basis of the property, you have to report the extra cash as income. The adjusted basis is the purchase price, increased or lowered for various factors, such as wear and tear on your car or a $15,000 remodeling job on your kitchen.
Even though you don't pay taxes on most theft or homeowners' reimbursement payments, they can still affect your tax bill. If you want to claim a theft or casualty loss as a tax deduction, you have to first subtract the insurance payout from the amount of your loss. That includes anticipated payments: If you suffer the loss in one year and won't get reimbursed until the next, you still subtract your expected payout from your losses.
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