After a personal injury settlement, many people want to know whether they will owe taxes on any portion of the recovery. In many cases, compensation received because of a personal physical injury or physical sickness is generally excluded from taxable income. However, certain portions of a settlement, including punitive damages and interest, may be taxable.
Harris Personal Injury Lawyer, Inc. represents injured clients throughout California. While we do not provide tax advice, we can discuss your personal injury claim and encourage you to consult a qualified tax professional about the potential tax consequences of a particular settlement. Call (619) 864-7101 to discuss your situation.
Most Physical Injury Settlements Are Not Taxable
Compensation received on account of a personal physical injury or physical sickness is generally excluded from federal taxable income under Internal Revenue Code Section 104(a)(2).
This means that if your settlement stems from an actual physical injury, whether a broken bone, a traumatic brain injury, or another physical harm, the money you receive to compensate for that injury is generally not something you need to report as taxable income.
Which Parts of a California Personal Injury Settlement Are Usually Tax-Free?
Much of the compensation received after an accident is tax-free and dedicated solely for your continuing health and the restitution of expenses.
Medical Expenses and Future Medical Care
Compensation for medical bills and anticipated future medical care related to a personal physical injury or physical sickness is generally excluded from taxable income. This treatment may differ to the extent a person previously deducted the same medical expenses and received a tax benefit from those deductions.
Pain and Suffering From a Physical Injury
Damages awarded for pain and suffering that stems directly from a physical injury are generally not taxable, since this compensation is considered part of the broader recovery tied to the underlying physical harm.
Lost Income Caused by a Physical Injury
Although wages earned from employment are ordinarily taxable, damages for lost income may generally be excluded when they are received on account of a personal physical injury or physical sickness. The facts of the claim and the nature of the payment matter.
When Is a Settlement Taxable in California?
Not every dollar in a settlement receives this favorable tax treatment. Certain categories of damages are generally taxable, regardless of whether they arose from the same underlying physical injury claim.
Punitive Damages
Punitive damages are generally taxable, even when they are awarded in a case involving a personal physical injury. Interest paid on a settlement or judgment is also generally taxable separately from the underlying physical-injury damages.
Interest on a Settlement or Judgment
Interest that accrues on a settlement or judgment, whether during litigation or afterward, is generally taxable as ordinary interest income, separate from the underlying settlement amount itself.
Emotional Distress Without a Physical Injury
Compensation for emotional distress that is not attributable to a personal physical injury or physical sickness is generally taxable. Emotional distress damages connected to an underlying physical injury may be treated differently. In addition, the tax code allows an exclusion for damages that reimburse medical care attributable to emotional distress, up to the amount paid for that care.
Reimbursed Medical Expenses Previously Deducted
If you previously deducted medical expenses on your tax return and later received a settlement that reimburses those same expenses, the reimbursed amount may become taxable to the extent you received a tax benefit from the earlier deduction.
Does California Tax the Same Settlement Funds as the IRS?
California tax treatment is often similar to federal treatment because California taxable income generally starts with federal adjusted gross income and then applies California-specific adjustments. The tax consequences of a settlement can depend on the type of damages, the terms of the agreement, prior deductions, and other facts. A qualified tax professional can advise you about your specific federal and California obligations.
How Settlement Language Can Affect Tax Treatment
Settlement documents should accurately describe the claims being resolved and the nature of the damages at issue. While the language of an agreement can be relevant, tax treatment depends on the underlying facts, the legal basis for the payment, and applicable tax law, not solely on the labels used in the agreement. A personal injury attorney and qualified tax professional can help you evaluate these issues before you finalize a settlement.
Structured Settlements and Lump-Sum Payments
A settlement may be paid in a lump sum or through periodic payments. For qualifying damages received on account of a personal physical injury or physical sickness, the method of payment does not by itself make the damages taxable.
However, interest or investment income associated with a payment arrangement may be taxable. Review the proposed settlement terms with your attorney and a qualified tax professional before accepting an offer.
What Should You Do Before Accepting a Settlement?
Before accepting a settlement, review exactly how the settlement agreement categorizes each component of the payment, consult with a qualified tax professional about your specific situation, and ask your attorney to help ensure the settlement language clearly reflects the nature of your damages.
Taking these steps before signing can help prevent confusion or an unexpected tax liability after the fact.
Talk With a California Personal Injury Lawyer About Your Claim
Harris Personal Injury Lawyer, Inc. represents people injured throughout California in a range of personal injury matters. We handle cases on a contingency-fee basis, so clients pay no upfront attorney’s fees and the firm receives a fee only if it obtains compensation.
We do not provide tax advice. If you receive or are considering a settlement, a qualified tax professional can advise you on the potential tax treatment of the specific payment. To discuss your injury claim and legal options, request a free consultation with Harris Personal Injury Lawyer, Inc. or call (619) 864-7101.