Are Car Accident Insurance Settlements Taxable in California?

March 24, 2021 Posted In Car Accidents

As tax season arrives, you may be wondering if a car accident settlement you received must be claimed on your tax return. Fortunately, the majority of car accident insurance settlements are not taxable in California. However, there are a variety of factors that can impact if you will need to pay taxes on some or all of your settlement. Before you sign any documents for an insurance company or accept a settlement, consult with an experienced car accident lawyer. 

When are Car Accident Settlements Taxable in California? 

Depending on the types of compensation you receive, the State of California and the federal Internal Revenue Service (IRS) may impose taxes. For example, the IRS’s Settlements – Taxability guide states that taxes may need to be paid on the following kinds of compensation: 

  • Medical Expenses: if part of the settlement is for accident-related medical costs that you deducted for prior year(s), and they resulted in a tax benefit, you will owe taxes on that compensation. If part of the settlement is for medical expenses for multiple years, you will have to pay pro rata taxes on the total amount of medical expenses paid for each year they were listed as deductions. If you paid for medical expenses in previous years and did not take deductions on your tax returns for them, then the compensation you recover  for medical expenses is tax-free. 
  • Lost Wages: since you would have had to pay taxes on your wages had you been working, you will have to pay them for any lost income settlement compensation you receive. The amount of taxes you will need to pay will depend upon how much you would typically pay on your wages. 
  • Property Damage: settlement compensation related to property damage is not taxable, unless the amount you receive exceeds the property’s adjusted basis (net cost of an asset). If that is the case, taxes must be paid on the excess amount, just as regular income. 
  • Pain and Suffering: any compensation you receive in a settlement for your pain and suffering, as well as other non-economic damages that are related to the physical injury or illness you sustained, are not taxable. 
  • Punitive Damages and Interest: any compensation received as punitive damages or interest on the settlement is taxable by the IRS, as “Other Income.” Punitive damages are awarded to punish the defendant. Whereas, interest can be added to your verdict by the court for the amount of time your claim has been pending. 

Get Help on Paying Settlement Taxes

Your car accident attorney can help you understand the specific tax repercussions of your settlement. If part or all of it is taxable, you will need to list the applicable awards on your tax return statement. Additional taxes are not imposed by the State of California in addition to the taxes from the IRS. However, only a tax specialist can give you absolute certainty as to which taxes you will have to pay on your settlement, in order to avoid penalties and fees. 

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