Hurt in a serious accident in California? You have the right to file for compensation through a personal injury claim against the at fault party and/or its insurance carrier. Many personal injury claims are settled. If you are in line for a settlement, you may be wondering: Will I have to claim my settlement on my taxes? The short answer is that you generally do not need to report a personal injury settlement to the IRS, though there are some exceptions to the rule. Here, our Stockton personal injury lawyers provide a comprehensive guide to the key points to know about personal injury settlements and taxes in California.
The Law on Personal Injury Settlements and Taxes: Internal Revenue Code Section 104(a)(2)
The purpose of personal injury compensation is to put the victim back into the same position that they would have been in had no accident ever happened. For that reason, the damages recovered through a personal injury settlement are generally excluded from gross income and, as a consequence, not subject to federal income tax. The relevant regulation is Internal Revenue Code Section 104(a)(2). Among other things, it holds that personal injury settlements, whether a lump sum payment or periodic payments, are not taxable income as long as they are for physical injuries or physical sickness. To be clear, you will not be taxed on any of the following types of compensation in a personal injury settlement as long as you have a corresponding physical injury:
- Medical bills;
- Lost wages;
- Pain and suffering; and
- Long-term disability.
Note: California has similar regulations at the state level for personal injury settlements and taxation. In other words, your personal injury settlement is also generally exempt from state-based income taxes in California.
Know the Exceptions: Parts of a Settlement that Might Be Taxable Income
As a general rule, personal injury settlements are neither subject to federal taxes nor California state taxes. However, there are some limited exceptions to the rule. You may be required to pay taxes on (part) of the proceeds of a personal injury settlement if the following compensation is included:
- Punitive Damages: Punitive damages are always taxable, even if awarded in connection with a physical injury. It is true under both federal regulations and California regulations. These damages are meant to punish the defendant, not compensate the victim.
- Emotional Distress Damages (Without Physical Injury): If emotional distress is not directly caused by a physical injury, the associated compensation is taxable. Only medical expenses related to that emotional distress may be excluded for tax liability.
- Interest on the Settlement: In some cases, a personal injury settlement will be paid with interest. Any interest that accrues on the settlement amount, such as post-judgment interest, is taxable as ordinary income.
It is imperative that your personal injury settlement is properly structured to avoid any adverse tax implications. Indeed, careful professional drafting of the agreement and the proper allocation of funds can help to maximize the amount of money in your pocket. A Stockton personal injury lawyer will ensure that you have the most favorable settlement agreement.
Understanding the Reporting Requirements for Personal Injury Settlements
Beyond the issue of tax liability itself, you may have questions about your reporting requirements after getting a personal injury settlement. The reporting obligations for personal injury settlements depend on the nature of the compensation being provided to the recipient. Under IRC § 6041, payors, most often insurers, but also sometimes defendants, must issue Form 1099-MISC to claimants for any taxable portion of a settlement, such as punitive damages, interest, or compensation for emotional distress not linked to physical injury. However, no Form 1099 is required when the entire settlement qualifies as non-taxable under IRC § 104(a)(2).
The Bottom Line: If you are issued a Form 1099-Misc in relation to your settlement, you may be required to report that information on your tax return and you may have some form of tax liability. If you received a Form 1099-Misc for a personal injury settlement, the IRS also got a copy as well. With that being said, most personal injuries are entirely tax exempt. There is no tax reporting requirement to the IRS if your entire settlement is tax-free. If you have specific questions about this issue, a lawyer and/or tax professional can provide support.
You Need the Maximum Compensation After a Serious Accident
Before you even think about something like taxes, it is imperative that you are in the best possible position to secure the absolute maximum personal injury settlement. A top-tier Stockton, CA personal injury lawyer can review your case, gather relevant evidence, and fight to hold the defendant/insurance company accountable. Do not go it alone. They want to pay out less in settlement negotiations. Our firm can help. You may be able to recover compensation for:
- Property damage;
- Emergency medical care;
- Hospital bills;
- Other health care costs;
- Pain and suffering;
- Loss of wages;
- Loss of earning power;
- Pain and suffering;
- Mental distress;
- Reduced quality of life; and
- Wrongful death of a family member.
How Our California Personal Injury Attorney Can Help
Navigating a personal injury claim can bring a lot of financial challenges. It is normal to have a lot of questions about your tax responsibilities after receiving a settlement. Our team is here to help you work through each and every step of the claims process. At Redkey Gordon Law Corp, we have a proven history of case results in complex personal injury claims. Our firm has recovered more than $25 million for victims and families across our practice areas. Your initial case evaluation with our Stockton personal injury attorney is free and confidential.
Call Our Stockton Personal Injury Lawyer for a Free Case Review
At Redkey Gordon Law Corp, our Stockton personal injury attorney has the professional expertise that you can trust. If you have any specific questions or concerns about personal injury settlements and taxes, we are here to help. Contact us today for a free case review. From our Stockton office, we represent injured victims throughout all of the San Joaquin Valley.