Are Personal Injury Awards Taxable in California?

The general rule is that the proceeds for compensatory damages, such as medical bills, from a personal injury claim are not taxable under federal or state law. This rule applies whether the claim was settled prior to or after filing a lawsuit, or if the proceeds were awarded in a verdict following a trial.

Under 26 U.S. Code 104(a)(2), compensation that you recover for your medical expenses for your physical injuries is excluded from your gross income and is generally not taxable by the IRS or the State of California. However, if you claimed itemized deductions for some of your medical expenses on your income tax forms while your lawsuit was pending, you will have to include those amounts and report them to the IRS under 26 U.S. Code § 104(a). This subsection specifically states that any medical expenses that you claimed as itemized deductions during the year when you incurred them cannot be later excluded from your gross income when you receive your settlement or verdict award. 

The reason for the general rule is that compensation for compensatory damages is meant to essentially reimburse an individual for the losses suffered as a result of an injury. As such, any compensated gain is meant to offset the losses, so there is no net gain from the proceeds.

Personal injury claims include several types of cases that could fall into the general rule of non-taxable settlement proceeds. Some of the common types of non-taxable personal injury settlements include:

• Motor vehicle accidents
• Boating accidents
• Animal bites and attacks
• Slip and falls and other premises liability cases
• Dangerous or defective products
• Workplace accidents
• Medical malpractice 
• Dangerous or defective medications
• Wrongful death 

Unfortunately, most personal injury claims include compensation for many types of damages, so taxability is not always a straightforward question. For that reason, you should contact the trusted personal injury lawyers at Miller Wilmers APC for a Free Consultation as to the taxability of your personal injury settlement or award.

Exceptions to the Rule on Taxing Personal Injury Claims in California

There are several exceptions to the general rule that can present many complexities in determining the taxable portions of the settlement proceeds. Failure to properly include taxable portions of a personal injury settlement could result in severe tax penalties.

Punitive Damages and Interest Exceptions

In some cases, punitive damages are awarded to provide additional punishment for reckless or intentional behavior of the liable party and prevent similar conduct in the future. Compensation for punitive damages is awarded on top of compensatory damages, and as such, these proceeds are typically taxable. As stated above, this is because these damages are not intended to reimburse you for medical expenses or pain and suffering, but rather to punish the wrongdoer for their egregious or outrageous conduct that resulted in your injury. 

Additionally, the interest earned on a verdict or settlement amount from a personal injury claim is generally taxable. Many states have court rules that provide interest on a personal injury settlement or verdict for the time the case was pending before the court.

For example, if a verdict awards compensation to an injured party one year after the lawsuit was filed, the injured party could receive interest on the verdict amount starting from filing date and running until the payment is made.

Lost Wages

Lost wages due to an accident can be taxable in a personal injury suit as these wages were always taxable and the intent of providing these damages is to 'make you whole' for any losses sustained due to the accident. This means that those damages which are not intended to reimburse, could be taxable. 

Other Common Exceptions to the General Rule

In some cases, an injured person might sustain emotional distress damages from an accident or incident. Emotional distress commonly results from an injury, such as anxiety or depression following a significant injury. However, it can also be unrelated to any injury, such as seeing a close loved one suffer harm.

If the emotional distress damages are connected to a physical injury or illness, any compensation is generally not taxable. If the damages are not connected to a physical injury or illness, the compensation is typically taxable.

Personal injury settlements also often include compensation for lost wages while an individual recovers from an injury. Unfortunately, this portion of a settlement is generally taxable as income, according to the Internal Revenue Service.

It is important to understand the breakdown of a personal injury settlement to ensure the proceeds are properly reported for tax purposes. Call Miller Wilmers APC at 661.312.8370 to schedule.