Are Personal Injury Settlements Taxable?

Some personal injury cases can be settled for maximum compensation, meaning a large sum in the thousands or millions of dollars. It may also come with tax obligations.

Whether the lawsuit settlement agreement that resulted from your personal injury claim is taxable depends on several factors. It can also depend on what type of damages were included in the award.

Regardless, understanding the tax impact and implications of a personal injury settlement can be confusing and overwhelming. If you have received an acceptable settlement, then it’s important to know whether it is taxable and, if so, how to appropriately report it come tax time.

Are personal injury settlements taxable? For those wondering whether they will lose a significant portion of their settlement to taxes, we are here to explain everything about taxes and personal injury settlements.

The Truth About Personal Injury Settlements and Taxes in California

In the majority of cases, your personal injury award is taxable in accordance with the Internal Revenue Service (IRS) and California statutes. The IRS provides details on taxation of personal injury settlements in Publication 4335, including which compensatory damages are subject to tax and which are exempt.

Additionally, California’s Franchise Tax Board (FTB) charges a tax on components of received settlements that it considers income. The FTB’s guidelines for personal injury settlement taxes have similar requirements to those mandated by the IRS.

Settlements and compensatory damages can be classified into two types to determine whether the payments are taxable. The first one is associated with physical injuries, while the second involves matters relating to non-economic damages.

Types of Damages in Personal Injury Claims

Personal injury claims typically include different categories of damages:

• Real Damages caused by actual physical or non-physical injury. These cover bodily harm and severe injuries like traumatic brain injury, neck injuries, spinal cord injuries, broken bones, and disability. These may also include medical expenses, property damage, lost income, emergency care, and funeral expenses, among others.
• Emotional Injuries, such as mental suffering, emotional trauma, mental anguish, emotional pain, depression, and anxiety, among others.
• Punitive Damages are intended to punish the defendant for their behavior and deter them from engaging in similar conduct in the future. The amount of punitive damages awarded varies depending on the severity of the defendant’s conduct, the harm caused to the plaintiff, and other factors such as the defendant’s financial resources.

Exclusions for Federal and State Taxation

Until August 21, 1996, IRC Section 104(a)(2) had no hint of the term “physical” in relation to personal injuries or sickness.

The Code altered (SBJPA, PL 104-188) to exclude from gross income “the sum of any punishments (apart from punitive) obtained (whether by suit or agreement and whether as lump sums or as periodic payments) for the account of personal physical injuries or bodily disease”.

Are personal injury settlements taxable in California?

In California, most personal injury settlements are not taxable, but certain portions may be. The following are some important points in the tax implications of settlements:

• Remunerative penalties, including lost wages, received as a result of personal physical harm, are excludable from net income, except to the extent they will result in a significant portion of the settlement being lost to taxes or punitive awards.
• Compensations received for non-physical injuries, such as mental distress, defamation, and humiliation, are not subject to federal employment taxes.
• To be excused from gross revenue emotional distress, compensation damages must be ascribable to (associated with) tangible physical traumas or unhealthiness. These costs should not have been deducted before under IRC Section 213.
• According to IRC Section 104 (a)(2), psychiatric anguish is only excusable from revenue if acquired on account of physical wound or corporeal malady.
• There is one exception to the exclusion of retaliatory reparations from net money inflow. This exception applies to wrongful death compensation. Under state legislation, only punitive compensations are allowed for wrongful death suits.
• Recompenses acquired for job-associated issues, such as financial losses, failed paychecks, business profits, and advantages, are NOT excusable from total income unless a real, tangible trauma invoked this deficiency.

According to the General Rules for Specific Information Returns, any installment made to a plaintiff is considered a division and subject to data-filing requirements. Therefore, when a settlement payment is made by a defendant or an insurance company, a Form 1099 must be provided unless the settlement falls under a tax exception.

Generally, most personal injury settlements in California are tax-free. This includes any recovery from a claim of bodily injury or sickness. However, punitive damages from civil cases are not exempt from taxation and must be reported to the Internal Revenue Service (IRS) on your income tax return.

Additionally, if you received interest as part of your settlement, it is considered taxable income by the IRS. It is important to consult with a legal professional who can help you find the expert needed to ensure you are reporting all your income appropriately.

How to Maximize Your Settlement Amount

Legal proceedings can be complicated, even when you believe you have accurately valued your case and victory appears certain. Without proper knowledge of California law and potential tax implications, these oversights can still result in a devastating loss.

In most personal injury cases, settlement amounts can be influenced by insurance companies and aggressive insurance adjusters who seek to minimize the injured party’s compensation. In some cases, after compensation is paid, untrustworthy legal advisers try to take advantage of the victim’s ignorance and charge exorbitant fees.

Before accepting any settlement, review the terms carefully and ask for a clear breakdown of fees, taxes, and deductions. Seeking guidance from a qualified personal injury attorney or tax professional can help protect your compensation and avoid costly mistakes.

Be cautious of individuals who present themselves as professionals but prioritize personal profit over your recovery and well-being. Understanding that personal injury settlements are taxable can help you make informed decisions and protect more of the compensation you recover.

Work With An Award-Winning Personal Injury Law Firm

At Farahi Law Firm, we care about our clients and fight with dedication and professionalism to ensure their legal rights are respected and that they receive the fair compensation they deserve. We are highly knowledgeable in California law and tax issues and can provide you with expert guidance throughout the process.

As a personal injury law firm, we work on a contingency fee basis, meaning you don’t pay us unless we win your case. We are ready to hear about your case, understand it, and work aggressively to win the justice and compensation you deserve. We are available 24/7.

Call us now for a free case consultation. We speak English, Spanish, and Filipino.

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