A personal injury settlement often comes after a long period of physical and emotional suffering, and plaintiffs understandably want to collect all of their rightful compensation, minus the contingency fee paid to their lawyer for all of their hard work on the case. However, if you are close to settling a personal injury suit or even in the beginning stages of considering legal action, you may be wondering: Will I have to pay taxes on my settlement? The answer is that while most of your settlement will likely not be taxable, parts of it may be.
So how much of your settlement will go directly into your pocket, and which parts might the IRS and the State of California take a cut from? The distinction is between the different types of damages included in your settlement. At Sevey, Donahue & Talcott, we want to help personal injury victims in Roseville understand the claims process and what their eventual settlement might look like so that they can make informed decisions about their legal options. With that in mind, here is a breakdown of the different types of damages in a California personal injury suit and which ones may or may not be taxable.
Before we get into the different types of damages, let’s discuss what kinds of relevant taxes you are already paying as a California resident. A personal injury settlement is a form of income, meaning that the tax we are concerned about here is income tax. Some types of income are considered taxable, while others are not. Every person in the United States above a certain income level must pay federal income tax to the Internal Revenue Service (IRS). In addition, the State of California has its own, separate income tax, in contrast to some other states that only charge a sales tax. The federal and state tax codes are different, but in general, the parts of a personal injury settlement that are taxable by the IRS may also be taxable by the State of California.
Perhaps the biggest piece of good news for personal injury victims is that you will likely not have to pay any taxes at all on the portion of your settlement that covers medical expenses. The idea behind these damages is that you are simply having the defendant reimburse you for money you’ve already spent or will have to spend in the future, so you will not have to pay taxes on that reimbursement. The only exception is if you won damages for medical expenses you already claimed as deductions in a previous tax year, in which case you will have to report the part of your settlement that covers those expenses alone to the IRS.
Most personal injury victims are seeking compensation for more than just the exact cost of their medical bills. Most successful personal injury settlements will also include compensation for the intense physical and emotional pain and suffering that came as a result of the injuries. These types of damages are generally not taxable, but it is a bit more complicated than that. Here is how they break down:
The vast majority of personal injury cases involve a physical injury or illness, so, for most plaintiffs, damages for both physical and emotional pain and suffering are not taxable.
Many personal injury victims seek compensation for the wages they lost while taking time off work to recover, and for future lost income if their accident left them temporarily or permanently unable to work. The IRS considers these damages to be taxable income. This is because these damages are replacing income from work, on which you would ordinarily be paying taxes. This is likely the largest part of your settlement you will have to report to the IRS and the State of California.
You may be seeking damages for property repairs or replacement, especially if you were in a car accident. Because, like medical expenses, these damages are meant to reimburse you for money already spent, they will not be taxable. The only exception is if you receive damages for your property loss that go beyond the actual value of your property – for example, if you lost a car that was valued at $13,000 and received $20,000 in damages for that loss. In that case, you would have to report the amount that goes beyond the value – here, $7,000 – on your income taxes.
California law allows victims of the most egregious accidents to recover an additional type of damages, known as ‘punitive damages.’ These damages are always taxable, but they are also relatively rare. The vast majority of personal injury victims will never have to worry about paying taxes on punitive damages because they will likely not be able to recover them in the first place.
The IRS and the state can only lay claim to a small portion of your personal injury settlement. The rest of it is yours to keep after the contingency fees and legal costs have been deducted. So don’t worry: a successful personal injury case can often secure a very substantial amount of money to help you recover and move on with your life. The Roseville personal injury attorneys of Sevey, Donahue & Talcott want to help you win the settlement you deserve. Call now at (916) 788-7100 or contact us online to set up a free consultation.