When you receive a settlement or award from a personal injury claim, navigating the tax implications in California can be as complex as the case itself. It’s crucial to understand which parts of your compensation may be taxable. The Internal Revenue Service (IRS) sets guidelines on this matter, but state provisions can also play a role.
The good news!
Firstly, the good news is that most personal injury damages awarded as compensation for physical injuries or sickness are not taxable under federal or California state tax laws. It includes amounts received for medical expenses, pain and suffering, and legal fees associated with the physical injury claims. This rule generally applies whether you settled out of court or went to trial.
However, there are exceptions. For instance, if you deducted medical expenses related to the injury on previous tax returns and received a tax benefit from those deductions, you might need to include the corresponding compensation in your taxable income to prevent a double benefit. This is known as the “tax benefit rule.”
Some damages are taxable
Another point to consider is the distinction between physical and emotional injuries. Damages for emotional distress alone, without an accompanying physical injury, may be taxable. Also, if part of your settlement includes interest or punitive damages, these typically are taxable. Interest accrues on judgments from when the court awards damages until you receive payment, and the IRS considers this interest as income.
Punitive damages are awarded to punish the defendant rather than compensate the victim and are generally taxable. If your settlement includes punitive damages, it’s essential to have them listed separately in the settlement agreement or judgment to distinguish them from non-taxable personal injury damages.
Lost wages or lost profits are often a part of personal injury claims, and these are usually taxable since they replace income that would have been taxable. This rule mirrors the taxation you’d face on regular income or profits.
It’s best to have a financial strategy
Tax laws are subject to change, and nuances in your case may affect the taxability of your damages. It’s always wise to consult with a tax professional or personal injury attorney who can help you understand the tax implications of your personal injury settlement in California.
Remember, a careful approach to your settlement and its components can help ensure that you remain compliant with tax laws while maximizing the non-taxable benefits of your recovery. After all, personal injury compensation aims to help you recover from your losses, not create new financial burdens through unexpected taxes.
KAASS LAW is a premier litigation firm in Southern California. Please contact us at 310-933-5171