Are Court Settlements Taxed
Often, personal injury settlements only come after an extended period of physical and emotional suffering. The first question people usually want answered when considering a lawsuit is, “Are Court Settlements Taxed in California? Here are answers . . .
Once a personal injury case settles, plaintiffs understandably want to collect their rightful compensation, minus the contingency fees paid to the attorneys for their labor. The good news is, most of the settlement will not be taxable; however, some of the settlement may be subject to tax.
So how much will go to the injured party and how much will go to the IRS and the State of California? The answer lies in the distinct types of damages stated in the actual settlement document. Below is breakdown of several types of damages in a California personal injury lawsuit and taxability of each.
Understanding California Tax Laws for Residents
California residents pay state and federal tax based on income. In California, the Franchise Tax Board (“FTB”) considers personal injury settlements a form of income. But like regular income, some of the settlement money is taxable and some is not. While Federal and California state tax codes differ, in general, the parts of a personal injury settlement considered taxable by the IRS are also considered taxable by the State of California.
Medical Expenses Are Not Taxable
Fortunately, for victims of personal injury, any portion of the settlement used to cover medical expenses are not taxable, as these represent a reimbursement for medical expenses rather than income. However, if these costs were previously claimed as a tax deductions on a prior tax return, this portion of the settlement may need to be reported to the IRS and FTB.
Pain and Suffering: It Depends
Most personal injury lawsuits include more than just damages for medical expenses, they include damages for pain and suffering as compensation incurred by the injured party. While this portion of the settlement is not taxable, it can get complicated. Here is how the break down:
- Physical pain and suffering are not taxable. The IRS lumps physical pain and suffering together with medical expenses as a part of the settlement it calls “personal physical injuries or physical sickness.” In this instance no taxes are due on this portion of the settlement.
- In contrast, emotional pain and suffering are taxable when they occur without any associated physical injury.
Most personal injury cases involve some type of resulting physical injury or illness. As such, damages for physical, AND emotional pain and suffering may not be considered taxable income.
Damages For Lost Wages Are Taxable
Unfortunately, personal injury cases often result of the loss of work and victims will seek compensation for lost wages during recovery and or against future earnings depending on the severity of the injuries. In these situation, the IRS will consider those proceeds to be taxable income as they will replace the taxable earnings (wages) earned before or after the injury.
Often the largest portion of a settlement, these amounts will need to be reported on your state and federal tax returns.
Property Damages Are Not Taxable
Settlements for automobile and property damages are not taxable, but there are exceptions. Like medical expenses, the IRS and the State of California consider these damages as reimbursement for a car or home previously paid. The exception is when the dollar amount of the damages paid exceed the actual value of lost property. For example, if a car is valued at $10,000 and the personal injury victim receives $20,000 for the loss, the additional $10,000 received would be reported as taxable income.
Punitive Damages Are Taxable
In California, personal injury law allows victims to recover additional settlements known as punitive damages. These awards occur when the grievance, injury, or damage results form an egregious act of the defendant. These settlement dollars are always considered taxable.
Choosing the Right Attorney
Finding the right personal injury attorney can make a significant difference in how settlements are taxed both federally and in California. At RJS LAW our experienced personal injury legal team collaborates with clients to help negotiate and structure settlements in the most advantageous manner. We are here to help. Call us today at (619)-595-1655 for a free no-obligation confidential case review. Our team will review the facts and explain the options. We are here to help get the settlement victims deserve.