Great news! Most California personal injury settlements are tax-free.
The IRS excludes compensation for physical injuries from federal income taxes. California follows suit, so you typically won’t owe taxes on the core portion of your settlement.
However, there are exceptions, such as:
Punitive damages: Awarded to punish wrongdoing, these may be taxable.
Interest on the settlement: Interest earned might be subject to taxes.
Read the article for in-depth explanations and additional FAQs to fully understand the tax implications of your settlement.
Accident victims often wonder: Is my personal injury settlement taxable by the IRS or the state of California?
This is very much an understandable concern; after all, everything in life is taxed right? Fortunately, ninety-nine percent of the time, your recovery from a personal injury case will not be taxable. Indeed, that is simply the way the law is set up.
For the most part, your personal injury recovery is tax-free money that you receive. Even better, not only is it tax-free (which means that you don’t owe taxes) but, generally, you don’t even report your settlement to the IRS.
If you have any tax questions that are related to your own personal injury case, please get in touch with our team today. We will be able to review the specific circumstances of your case; further, an initial call to our firm is always free of charge. For a basic injury settlement, you likely do not need a tax professional. If your settlement includes punitive damages, interest, or if you deducted medical costs in prior years, a CPA review before you file is smart. One session is usually enough. The cost is small compared to filing it wrong.
Taxes and Personal Injury Claims: Four Frequently Asked Questions (FAQs)
What is the Value of My Case?
The value of your California personal injury case will always depend on the extent of your injuries and the amount of damages/losses you sustained. This is because, in general, legal damages are meant to be compensatory in nature. As such, the value of your case will generally correspond directly to the value of your damages.
Most personal injury awards are tax-free because of the regulations enacted by the IRS. The reason that the IRS made most recoveries tax-free stems from the fact that legal damages are meant to be compensatory. As an injured victim, you have a legal right to be made ‘whole’; or put another way,
you have the right to be put back into the same position that you would have been in had no accident ever taken place. For this to occur, your recovery must be tax-free. The bottom line: Almost all financial compensation recovered in relation to a ‘physical injury’ will not be taxed.
The federal rule is IRC Section 104(a)(2). It excludes from income damages received for physical injuries, except punitive damages. You do not report a tax-free settlement on your return. If the settlement includes taxable parts, like punitive damages or interest, you report only those. Keep a copy of your agreement in case questions come up later.
What Is the Exception?
There are a couple of important exceptions to general rules regarding taxation and personal injury cases. Most importantly, if you recover punitive damages, that portion of your recovery will be taxed. Two categories often raise questions. Lost wages: if they are part of a settlement for a physical injury, they fall under the same exclusion and are not taxed. Emotional distress: if it stems from a physical injury, the damages are excluded too. If the emotional distress claim has no physical injury behind it, that portion may be taxable. The IRS draws the line at whether the claim is rooted in physical harm.
Punitive damages are available in a very limited number of cases. These damages, unlike other personal injury damages, are not meant to ‘compensate’ the victim, but to punish the very bad actions of the defendant. Typically, your attorney will need to prove that the defendant was grossly negligent in order to seek punitive damages. Additionally, you may receive interest on your personal injury settlement or award. If this in the case, any payment for interest that you receive might be taxable. One rule catches people off guard. If you deducted medical costs on a prior return and then recover those costs in a settlement, you may owe tax on that part of the money. The IRS calls this the tax benefit rule. It only applies where your prior deductions gave you a real tax benefit. If you claimed medical deductions before your case closed, tell your tax preparer. This issue can be a little more complicated, so if it comes up in your case, it should be addressed by your attorney.
Are Settlements and Judgements Treated the Same Way?
Yes, voluntary settlement agreements and successful personal injury verdicts/judgments are subject to the same tax rules and regulations. For tax purposes, it simply does not matter whether you settle your claim or are forced to go all the way through the legal process to get the compensation you rightfully deserve.
Ultimately, if you have more questions, it is in your best interests to reach out to us at GJEL Accident Attorneys today. Our legal professionals are prepared to assist you throughout each step of your case.
