Are Personal Injury Settlements Taxable in California?
No, personal injury settlements are generally not taxable in California. However, there are exceptions to this rule that may require taxes to be paid on certain portions of a settlement, such as any amount awarded in punitive damages. If you have questions about your tax obligations for a specific settlement, contact an injury attorney at Rose, Klein & Marias, LLP for a free consultation.
The IRS Does Not Tax Most Personal Injury Settlements
Under federal tax law (Internal Revenue Code Section 104), a financial settlement that is awarded to compensate an individual for bodily injury or illness is generally not taxable. The Internal Revenue Service (IRS) does not classify personal injury claim damages as “gross income” for tax purposes. They are excluded from federal income taxation.
However, this tax rule only applies to settlements awarded on account of personal injuries and physical illnesses. If a settlement is awarded for emotional distress alone in California, with no corresponding bodily injury, this amount is fully taxable under federal law.
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What Parts of a Settlement Can Be Taxed?
The majority of personal injury settlements paid out in California are not subject to taxation under state or federal tax laws. Yet there are exceptions to the rule. It is important to be up-to-date on the most current tax laws in connection with your personal injury settlement so that you do not accidentally make a tax error.
Lost Wages
If a portion of a settlement reimburses the victim for lost wages, this amount must be reported as part of the individual’s ordinary income on federal and state tax returns. Since the claimant’s wages would have been taxed had he or she been able to go to work like normal, the claimant must pay taxes on a lost wage settlement.
Punitive Damages
Punitive damages are sometimes awarded in California personal injury cases where it is proven that the defendant acted with fraud, malice or oppression. Punitive damages are assigned as a form of punishment against the defendant to deter future acts of similar misconduct. Any portion of a settlement allocated for punitive damages is taxed as part of the recipient’s gross income under federal law.
Previously Deducted Medical Costs
If the plaintiff dealt with medical care connected to the injury for a long time prior to settlement, he or she may have already listed these expenses as itemized deductions in prior years for a tax break. If this is true, the portion of the settlement allocated for the same medical costs will be taxed in the new year to prevent a double deduction.
Interest
Any interest accrued on a personal injury settlement, such as interest gained through investments made with settlement money, is subject to taxation. This rule applies to both pre-judgment and post-judgment interest earned on a settlement.
Protect Your Recovery: Get an Attorney’s Help Structuring Your Settlement for Tax Purposes
If you get hurt in an accident and are granted a settlement by an insurance company, an experienced personal injury attorney in California will know exactly how to organize, structure and itemize your payout to preserve as much of it as possible. A lawyer has all the information needed regarding current tax laws to organize your settlement in a way that minimizes your tax liability and keeps more of your money in your pocket.