Are Personal Injury Settlements Taxable in California?
Personal injury settlements in California are typically not subject to state income tax since both compensatory damages covering economic losses and general damages addressing intangible losses are generally non-taxable.
However, specific components of a settlement, such as punitive damages or interest on an award, may be subject to taxation.
Are personal injury settlements taxable in California?
Upon receiving a personal injury settlement in California, the state does not impose taxes on the entire sum. Instead, California levies taxes solely on the segment of your settlement designed to compensate for economic losses. The tax rate is determined by the state's highest marginal tax rate, presently standing at 14.4%.
Are bodily injury settlements taxable?
Are compensatory damages taxable in personal injury vs bodily injury cases. In general, compensation awarded for physical injuries or property damage is typically not taxable, meaning you won't have to pay any taxes. This encompasses reimbursement for pain and suffering, lost wages, and medical expenses as parts of a personal injury lawsuit settlement.
However, it's important to note that punitive damages or interest received as part of the settlement may be subject to taxation.
Additional reading: Personal injury examples
When is a personal injury award taxable?
This does vary by state so may involve the type of case, special/general/punitive damages, as well as if the award exceeds the cost of losses.
Compensatory damages and punitive damages are potential outcomes of California personal injury settlements. Compensatory damages come in two forms:
Special damages: Encompass tangible losses, like lost wages and medical bills
General damages: Address intangible losses, such as pain and suffering or loss of consortium.
The Internal Revenue Service (IRS) deems punitive damages, interest on awards, and amounts surpassing actual damages, as recognizable tax liability in a personal injury lawsuit. While calculating tax liability, additional IRS guidelines apply to specific types of awards in a settlement amount from a personal injury lawsuit.
For example, lost wages, a potential portion of your settlement in a California personal injury lawsuit, may be subject to taxation unless they stem directly from the physical injury under consideration.
Damages awarded solely for emotional or mental distress in a personal injury lawsuit are federally taxable. Moreover, if medical expenses related to the incident have been previously claimed on a tax return, the IRS mandates their notification for tax compliance.
Are personal injury awards taxable by the federal government?
So, is a personal injury settlement taxable by the IRS?
Personal injury settlements remain non-taxable at the federal level, ensuring that the IRS does not claim any portion of your funds.
The federal government refrains from taxing settlement money, recognizing that these funds aim to compensate for the losses you have endured. This principle applies to both tangible economic damages, such as medical bills and lost wages, and intangible non-economic damages.
But, are pain and suffering damages taxable? Non-economic damages, specifically for pain and suffering and emotional distress, are exempt from taxation only when there is a concurrent physical injury. For instance, under California law, you'll have to pay taxes if a dog's aggressive behavior leads to PTSD without causing physical harm. This means that the damages for emotional distress would be taxable.
Economic damages escape taxation as they represent the recovery of lost funds, while non-economic damages remain untaxed to restore you to a whole state for losses that cannot be directly compensated, such as the pain experienced. These compensatory damages are regarded by the government as a means to offset a loss equivalent to the money received, thereby exempting your settlement from taxable income.
Are punitive damages taxable?
While the majority of personal injury compensation is generally not subject to taxation, there exists an exception for punitive damages. These damages, which are not granted in every personal injury case, may be awarded in instances where a defendant's misconduct is particularly egregious.
Punitive damages serve a different purpose than compensatory damages; they aim to punish the defendant and discourage future wrongful behavior rather than compensating the victim. As this money does not function to restore prior losses, there is a possibility of being taxed on the received amount. However, this exception does not apply in cases of wrongful death, where punitive damages remain non-taxable.
If you find yourself in a situation where you receive punitive damages, it is advisable to consult one of our Glendale personal injury lawyers and a tax attorney to determine the taxability status of your damages. Also, the personal injury statute of limitations in California generally allows individuals two years from the date of injury to file a lawsuit, so time is of the essence to act fast.
Are special and general damages taxable?
In personal injury claims, special damages pertain to costs that can be precisely determined — economic damages, such as:
Medical bills
Lost earnings
All out-of-pocket expenses incurred because of the injury
Vehicle repairs arising from a car accident
Property damage resulting from a defendant's negligence or intentional wrongdoing
In this context, some personal injury exemptions exist when it comes to taxation. Medical expenses form a part of a personal injury lawsuit and so are typically not considered taxable, but this depends on the circumstances of your case. For instance, these expenses become taxable if you covered medical costs for over a year or if you added an itemized deduction to medical cost taxes in previous years.
In most cases, general damages arising from personal injury settlements are not subject to taxation. General damages, which encompass intangible losses like pain and suffering or loss of consortium, are typically considered non-taxable income.
The rationale behind this exemption is rooted in the notion that these damages aim to compensate for non-economic hardships that lack a direct monetary value. While specific tax implications may vary depending on jurisdiction and specific circumstances, the general principle is that the compensation awarded for intangible losses is often exempt from taxation.
Our conclusion on tax on injury settlement
Answering, " are settlements taxable in California?" is clearly not a simple yes or no.
Generally, they are not subject to state income tax, particularly when they compensate for personal injuries. Both compensatory damages, which include economic losses like medical expenses and lost wages, and general damages, addressing intangible losses such as pain and suffering, are typically non-taxable.
However, exceptions do exist, and certain components of a settlement, like punitive damages or interest on an award, may be subject to taxation.
This makes it vital to consult with a our experienced personal injury law firm to ensure compliance with current regulations and address any specific considerations related to individual cases. Contact us today for tailored assistance regarding your situation.