When you are in negotiations or after you have received a personal injury settlement, it is normal to wonder if it is considered taxable income in California. The majority of it is not, but some portions can be depending on the types of compensation you receive.
The State of California and the federal Internal Revenue Service (IRS) impose taxes on the following kinds of compensation awarded in personal injury settlements, according to the IRS’s Settlements – Taxability guide:
If part of the settlement is for medical treatment and ongoing care costs related to the accident that you deducted in the prior year(s), then you must pay taxes if the deductions resulted in a tax benefit. If a portion of the settlement is for multiple years of medical expenses, pro-rata taxes must be paid on the total amount of medical expenses paid for each year they were listed as deductions. If you did not take deductions for the medical costs from previous years that you paid for, any compensation you recover for those medical expenses is tax-free.
Job income is taxable, so you would have had to pay taxes had you been able to work. As a result, you will have to pay taxes on any compensation you receive for lost wages. The amount of taxes you owe will depend on the amount that would typically be deducted from your wages.
In some cases, punitive damages are awarded if the defendant acted egregiously or with malicious intent. Any compensation received as punitive damages is taxable by the IRS as “Other Income.” The same goes for any interest that the court adds to your verdict, which is sometimes done to offset the amount of time your claim has been pending.
There are two types of compensation that are commonly awarded in personal injury settlements that are not taxable:
The compensation you receive for your pain and suffering, both physically and emotionally, as well as other non-economic damages that are related to your injury or illness, are not taxable.
Settlement compensation for property damage is not taxed unless the amount you receive exceeds the property’s value. Taxes are owed just as regular income on any amount beyond the adjusted basis (net cost of an asset).
The state of California does not impose taxes in addition to the IRS.
Our highly skilled team at CaseyGerry can help you understand the potential tax repercussions from your settlement, as well as which types of compensation, must be listed on your tax return statement to avoid penalties and fees. Call (619) 238-1811 to set up a free consultation