Are Personal Injury Settlements Taxable?
Some personal injury cases can be settled for maximum compensation, which means a big amount of money 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 also can 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 if they are going to lose a significant percentage of their settlement in tax obligations, we are here to explain everything about taxes and personal injury settlements.
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The Truth About Personal Injury Settlements and Taxes in California
In the majority of cases, your personal injury award is taxable in accordance with Internal Revenue Service (IRS) and California statutes. The IRS provides details regarding taxation on personal injury settlements in Publication 4335, including information on which compensatory damages are subject to taxes and which are excused from them.
Additionally, California’s Franchise Tax Board (FTB) charges a tax on components of received settlements that it regards as a type of 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 decide whether the payment qualifies as taxable or not.
The first one is associated with physical injuries, while the second involves matters relating to non-economic damages. Personal injury claims commonly fall under three headings:
- 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. Real damages may also include medical expenses, property damage, lost income or business 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”.
The following are some important points in tax implications of settlements:
- Remunerative penalties, including lost wages, received as a result of personal physical harm are excludable from net income apart from punitive awards.
- Compensations received for non-physical hurts such as mental distress, defamation, and humiliation are not liable 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 Section104(a)(2), psychiatric anguish is only excusable from revenue if acquired on the score of physical wound or corporeal malady.
- There is one exception to retaliatory reparations being excluded from net money inflow. This exception applies to compensations for wrongful death. 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 furnishing 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 amount, it is also 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 and even when you have valued your case and the victory is in your hands, not having proper knowledge about California law and tax implications can result in a terrible loss.
In most personal injury cases, the settlement amount can be affected by insurance companies and aggressive insurance adjuster’s judgment who try to minimize the compensation award for the injured party.
In other cases, the financial compensation is settled and when the money is delivered to the victim, there are untrustworthy legal advisers that try to take advantage of a personal injury victim’s ignorance and apply uncountable taxes unto their legal services.
Don’t be fooled by pseudo-professionals who are only interested in your money and not your well-being.
Work With An Award-Winning Personal Injury Law Firm
At Farahi Law Firm, your justice is our cause! We care about our clients, and we fight with dedication and professionalism to ensure that their legal rights are respected and that they get the fair compensation they deserve. We are highly knowledgeable in California law and tax issues and can provide you with expert guidance all throughout the process.
Your search for a No Fee Guarantee lawyer is over! As an award-winning personal injury law firm, we work on a fee contingency basis, which means you don’t have to pay us until we win your case.
We are ready to hear about your case, understand it, and work aggressively to win the justice and fair compensation you deserve. We are available 24/7.
Call us now for a free case consultation. We speak English, Spanish, and Filipino.