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Is My Personal Injury Settlement Taxable?

Were you hurt in a serious accident in Stockton, San Joaquin County, or elsewhere in California? You may be entitled to recover compensation for your damages from the at-fault party and/or their insurance company. Most personal injury cases are resolved via a settlement rather than a trial verdict. You may be wondering: Is a personal injury settlement taxable? For the most part, the answer is “no”—though there are some exceptions. In this article, our Stockton personal injury lawyer provides a comprehensive guide to the most important things that you should know about personal injury settlements and taxation. 

Background: Personal Injury Compensation is Designed to Make the Victim “Whole”

A personal injury claim is a type of civil cause of action. Personal injury law plays a vital role in our overall justice system. The core purpose of a personal injury case is relatively straightforward: The aim is to restore the victim into the position that they would have been in had the accident never occurred. The primary way that this is accomplished is through financial compensation. In California, personal injury compensation—what is paid out through a settlement—is meant to make the victim “whole.” A person is only made whole after an accident if they can hold the at-fault party liable for the full extent of their damages, including non-economic losses. 

IRS Guidance: Personal Injury Compensation Generally Not Taxable Income

Are personal injury settlements taxed? While the answer technically is “it depends”, the reality is that personal injury compensation is generally not treated as taxable income. As explained by the Internal Revenue Service (IRS), “actual damages resulting from physical or non-physical injury” are generally exempt from federal taxation. 

The compensation is not counted as gross income. Notably, the exemption from taxation applies to both economic and non-economic damages. In other words, personal injury compensation that covers medical bills, lost wages, and pain and suffering is generally not subject to federal taxes. The IRS’s position is that the settlement simply replaces what the injured party lost due to the injury. 

A Note On California State Taxes: In line with federal law, California also exempts personal injury settlements from state taxation. This means that, in California, individuals receiving personal injury compensation will not see their settlement reduced by state taxes. This policy reinforces the principle of making victims whole

The Two Big Exceptions to the General Exemption for Taxation of a Tort Settlement

It is important to clarify that there are some exceptions to the rule. Although personal injury settlements are generally not taxable income in California, you may be required to pay taxes on your tort claim in certain limited situations. Here is an overview of the two major exceptions to the general rule that personal injury compensation is tax-exempt income: 

  • Emotional Distress Without Physical Injury: Compensation for emotional distress is taxable if it does not stem from a physical injury. To be clear, the IRS distinguishes between emotional distress arising from physical harm (non-taxable) and emotional distress as a standalone claim (taxable). The distinction is crucial in understanding the tax obligations that may arise from certain components of a settlement. A personal injury settlement must be structured properly. 
  • Punitive Damages: Punitive damages (exemplary damages) may be included in certain limited personal injury cases. Under California law (California Civil Code § 3294), punitive damages are compensation that may be recovered in addition to actual damages “for the sake of example and by way of punishing the defendant.” Unlike compensatory damages, punitive damages are taxable. These are awarded not to compensate the victim but to punish the wrongdoer. Since they are not tied to the concept of making the victim whole, punitive damages are subject to taxation.

The Taxation of Verdicts are Treated Similar to the Taxation of Settlements

Much like personal injury settlements, the taxation of personal injury verdicts follow similar principles. Whether a victim receives compensation through an out-of-court settlement or a court-awarded verdict, the tax implications are consistent. Compensatory damages awarded for physical injuries or sickness in a verdict are not taxable. There is full alignment with the IRS’s treatment of settlements. Notably, jury verdicts in California for personal injury claims are also generally not subject to state-level taxation. However, as with settlements, there are notable exceptions. Taxation applies to compensation for emotional distress not originating from physical injury and to any punitive damages awarded.

Injured Victims Deserve a Full and Fair Personal Injury Settlement 

Taxes are only one issue that needs to be addressed in the personal injury claims process. Before you worry about taxes, you need to be sure that you are in a position to receive financial compensation for the full extent of your damages. Sadly, you cannot trust a big insurance company to willingly offer a fair settlement. Depending on the nature of your case, you may be eligible to recovery compensatory damages for: 

  • Property damage, such as vehicle repairs; 
  • Emergency medical treatment; 
  • Hospital bills and other medical costs;
  • Lost wages and loss of earning ability; 
  • Pain and suffering & mental distress; 
  • Long-term disability; and
  • Wrongful death damages. 

Navigating a personal injury claim and understanding its tax implications can be complex. Do not go it alone. A top-tier Stockton, CA personal injury lawyer can help ensure that the settlement not only addresses all aspects of the victim’s damages but also considers the tax implications to maximize the compensation retained by the victim. At Redkey Gordon Law Corp, we fight hard to help our clients secure the absolute maximum financial compensation. 

Contact Our Stockton, CA Personal Injury Attorney for a Free Case Review

At Redkey Gordon Law Corp, our Stockton personal injury lawyers are local advocates who deliver big-time results for victims and families. If you have any specific questions or concerns about the taxability of a personal injury settlement, we are here to help. Contact our personal injury team today for a free initial consultation. From our Stockton law office, we fight for the rights of injured victims throughout the San Joaquin Valley, including in Sacramento, Sutter Creek, Lodi, and Manteca.