Are Personal Injury Settlements Taxable in California?
- In California, most components of a personal injury settlement are not considered taxable income.
- Compensation received for physical injuries or sickness remains exempt from federal and state taxes.
- Lost wages are taxable since they compensate for income you would have had to pay taxes on.
- Compensation received for emotional distress that does not stem from a physical injury can be taxable.
- Punitive damages are often considered taxable.
- Are Personal Injury Settlements Taxable in California?
- What Is a Personal Injury Settlement?
- Do I Need To Pay Taxes on a Personal Injury Award?
- What Parts of Personal Injury Settlements Are Taxable in California?
- How Should I Report Taxable Personal Injury Settlements?
- How Can Cutter Law Lawyers Help With Your Personal Injury Compensation?
Are Personal Injury Settlements Taxable in California?
The general rule in California is that most components of personal injury settlements are not taxable income. Generally, the compensation received for physical injuries or sickness remains exempt from federal and state taxes. This rule applies whether you have received a lump sum or a series of payments for a few years.
However, there are exceptions to this rule. For example, lost wages are taxable since they compensate for income you would have had to pay taxes on if you were working. Also, the compensation you received for mental anguish or emotional distress that does not stem from a physical injury can be taxable.
Additionally, punitive damages are often considered taxable, even those related to a physical injury or sickness. Typically, interest on the settlement is also taxable.
| Non-Taxable Components | Taxable Components |
| Compensation for physical injuries | Lost wages |
| Medical expenses reimbursed | Punitive damages |
| Lost earning capacity or future earnings (from physical injury) | Interest on the settlement amount |
| Pain and suffering (from physical injury) | |
| Emotional distress (from physical injury) |
What Is a Personal Injury Settlement?
A personal injury settlement refers to the compensation awarded to an individual who has suffered harm due to another party’s negligence or intentional conduct.
These settlements provide compensation for both economic and non-economic damages, such as:
- Medical expenses
- Lost wages
- Lost earning capacity
- Pain and suffering
- Emotional distress
- Loss of enjoyment of activities
- Property damage
Do I Need To Pay Taxes on a Personal Injury Award?
The tax implications surrounding personal injury awards hinge upon the specifics of your case. However, state and federal governments refrain from taxing personal injury awards according to the specific exclusions in the Internal Revenue Code Section 10412. The federal government does not tax most of your settlement money since these funds received are intended to compensate you for the losses you endured.
Here are some categories of personal injury cases where the awards remain exempt from federal taxation:
- Compensation for pain and suffering and most non-economic damages: This compensation remains non-taxable if the pain and suffering and other non-economic damages stem from a physical injury.
- Medical expenses: In cases where you receive a settlement for personal physical injuries or physical disorders and have not itemized deductions for medical expenses in previous years, the entire sum remains non-taxable.
What Parts of Personal Injury Settlements Are Taxable in California?
In California, personal injury settlements are not taxable. However, exceptions do exist. For example, taxation occurs if the settlement includes:
- Medical expenses deducted on previous tax returns are taxable. The rule is if you had medical costs lasting for over a year and took those expenses as itemized deductions on previous years’ returns, you must pay taxes on the amount you recover for them.
- Settlements earmarked solely for emotional distress unrelated to a physical injury may become taxable. This only applies to injuries that are purely emotional and are unrelated to a physical injury. If the emotional distress stems from a physical injury, it is not taxable.
- Punitive damage awards designed to penalize the guilty party for gross negligence or malicious intent may be subject to taxation.
- Lost wages, future earnings, and earning capacity may be taxable since you would have had to pay taxes on this income if you received it from working. This tends to be the largest taxable portion of a personal injury settlement.
When you receive a personal injury settlement in California, the entire amount is not taxed. Instead, you must only pay taxes on the portion of your settlement that compensates for taxable losses. The highest marginal tax rate in the state is currently 13.3 percent.
How Should I Report Taxable Personal Injury Settlements?
You must report any taxable awards as income on Form 1099-MISC or Form W-2. You can often include it as “other income” on your taxes. For example, if you receive a settlement with punitive damages, you must report it to the IRS. You must also register any interest earned on your settlements at tax time.
If you report any amount of your compensation for pain and suffering on your taxes, attach a statement to your tax return. Your statement should include your entire settlement amount minus any eligible medical costs you still need to deduct or expenses you deducted without receiving a tax benefit.
How Can Cutter Law Lawyers Help With Your Personal Injury Compensation?
At Cutter Law P.C., our legal team can structure a settlement during negotiations with the opposition to minimize the taxes by allocating more of the damages for non-taxable components while allocating less to taxable portions.
If you want to know whether your personal injury compensation is taxable, we can help you determine which awards are and are not taxable. We can guide you through the various tax implications of your settlement. In turn, you can know what you may owe and how to report it on your tax return.
If you would like to learn more about the potential tax implications of personal injury settlements in California, contact us to schedule a free case review.
Non-economic damages are those quality of life losses that you sustain in an injury, including the pain and suffering, humiliation, and grief.
Punitive damages are awarded punish a defendant for malicious conduct. Punitive damages are not available in all cases.
Economic damages are the losses you can measure with dollars and cents, such as your lost wages, your past medical bills, and your future medical bills.