Injured victims of car accidents are often understandably concerned about the tax implications of their settlements. After the financial turmoil and stress that are usually experienced in these cases, it is common to wonder whether you’ll be required to pay taxes on your settlement money.
California does not have full control over taxes that may be due as a result of receiving a settlement award. The Internal Revenue Service (IRS) may require taxes to be paid on certain kinds of compensation, including the following:
- Compensation paid to you for medical expenses that were deducted the year prior and resulted in a tax benefit could be taxable. If your medical expenses span multiple years, the pro rata tax amount must be calculated for each year they were included as deductions on your taxes.
- Settlement funds dedicated to your lost wages will likely be taxed. The specifics of taxation will be determined by how taxes are handled with your regular income or wage.
- If you receive money for property damage that exceeds the property’s net cost, you must pay taxes on the additional amount.
- Punitive damages are taxable by the IRS. They are considered income and will be taxed as such.
Physical sickness is included in addition to injuries. However, awards that are granted solely for emotional distress do not fall within the same guidelines as physical injury and illness. In the context of taxation, emotional distress does not classify as either physical illness or injury, so damages for mental anguish and other emotional distress are considered in gross income and are taxable.
California, similarly to the IRS, does not tax the entire personal injury settlement you receive. Only portions that are considered compensation for economic losses are taxed by California. The most common occurrence of California taxing settlement awards is for punitive damages.
Punitive damages, also called exemplary damages, differ from compensatory damages. Punitive awards are intended to punish the liable party rather than compensate the victim for financial losses. These are relatively rare in personal injury cases as there is a requirement that the behavior of the defendant was intentional or extremely reckless. California Civil Code § 3294 specifically states that malice, oppression, or fraud must be present for punitive damages to be awarded.
The tax rate for settlement awards in California is generally 13.3%. Of course, there are exceptions to this taxation rule. Workers’ compensation claims and medical malpractice are two examples.
If you move to California from another state after receiving a settlement in that state, you may still be required to pay taxes on the amount if a reciprocal agreement exists. These agreements are made between California and other states in which each state agrees to tax the residents from other states. This includes personal injury settlements.
In addition to the taxation factor in calculating your final settlement amount, there are also other considerations that may affect your compensation. Some medical insurers place liens on settlement money to recoup the costs of the medical care necessitated by your injury. Any outstanding or overdue medical expenses may also need to be addressed with a settlement award.
Consulting with an accident attorney is always a good idea when you are considering accepting a settlement offer. While a lawyer will not be able to change how the IRS or the state of California taxes certain income and awards, they can help to make the tax payments less impactful.
It may be possible to request an adjustment to the allocation of the settlement money. For example, designating more money to go toward physical injuries and minimizing punitive damages awards can reduce the amount of tax required. Again, California does not generally tax compensation awarded for property damage or physical injuries. Punitive damages, compensation for lost wages, and an award for emotional distress may be taxable in California.
The Accident Network Law Group will do everything possible to get you the compensation you deserve while minimizing your tax obligations. Contact us today to schedule a free consultation by calling (951) 554-1010.