Largest auto settlement in U.S. history means half a million taxpayers could owe IRS

Following a Federal Trade Commission (FTC) settlement with an automaker earlier this year, nearly 500,000 car owners and lessees could receive a cash payment of at least $5,100. And depending on how the IRS interprets this settlement, those taxpayers could have to pay taxes on part – or all – of their settlement.

The IRS has not yet indicated how it will handle the settlement, but Lynn Ebel, manager at The Tax Institute at H&R Block said there are several different components of the settlement, so it’s important to keep some basic tax rules in mind when interpreting the payments.

First, the cash payment is at least $5,100 partially based on 20 percent of the car’s value the date before the violation’s disclosure. This could be considered a reduction in the original purchase price and it would lower the taxpayer’s basis in the vehicle. In other words, it is a retroactive discount on the car. When the taxpayer sells the car, it would impact the amount of the owner’s gain or loss realized.

“If the owner ends up turning a profit on the sale of a personal car, the owner could owe capital gains tax. However, this will likely be rare,” said Ebel. “Used car sales usually result in a loss to the individual seller if the car was not used for business, and this will most likely be true even with the 20 percent cash settlement. And losses on personal property are not tax deductible, so there would be no tax impact to the car owner.”

However, part of the cash payment the automaker is set to make is a fixed dollar amount payment. If the IRS interprets this part of the settlement as not relating to the car’s value, it would be a taxable cash settlement.

Some owners may have additional complicating factors such as loan forgiveness or business use of the vehicle. Regardless of the facts and circumstances, all owners should keep records substantiating their basis and for a copy of the settlement agreement explaining what the payment was for.

So while it remains to be seen how the IRS will interpret the settlement and what the impact will be to the taxpayer, Ebel advises taxpayers to consider that a portion of the settlement may potentially be taxable and to set aside a portion of the settlement when they receive it.

“Taxpayers don’t want to end up owing the IRS at tax time because of a settlement with their car manufacturer. If they receive their settlement as a credit on their debt instead of a check, they should be prepared to cover any resulting tax out-of-pocket,” said Ebel.

For more information, taxpayers can visit the FTC page on the settlement or the IRS’ settlement guide.