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Do I Have to Pay Tax on an Injury Settlement in California?

California adheres to the guidelines of the IRS with respect to which items should be included in income. When preparing your California state tax return, you must attach a copy of your federal return (Form 1040). Other income items such as awards and settlements are shown on line 21 of the federal return ("Other Income"). The IRS has specific rules that apply to award settlements, and the taxability depends on what the injury settlement represents.

The Taxable Portion of Award Settlements

    Since the state of California uses the federal adjusted gross income in its tax calculation, you'll need to look at the federal return to determine if an injury settlement you receive is recognized as income. The IRS generally considers all income taxable unless specifically exempted by code. The IRS considers proceeds from a personal-injury settlement not taxable, except for the portion of the settlement that represents lost wages. Wages are always taxable.

Settlement Structure

    The structure of an injury settlement is critical when determining whether or not it is taxable. Any portion of the settlement that specifically addresses injury or reimbursement for specific medical costs is generally not taxable. These are items that the IRS views as making a person "whole again." The IRS will look closely at the structure of a settlement to make sure there is a fair allocation between injury reimbursement and lost or back wages.

How an Injury Settlement Is Reported on California Taxes

    When you file your state return (Form 540), you'll attach a copy of your federal return and also take the adjusted gross income off the federal return and transfer it to your state return on line 13. The federal adjusted gross income (AGI) should include the taxable portion of any injury settlement. The state return must be filed by April 15th following the last tax year, along with the federal income tax form.

Considerations

    Since personal-injury settlements can result in substantial compensation, you should have a tax attorney or tax professional such as an enrolled agent or CPA review your injury settlement to make sure the taxable portion is properly shown and also that the nontaxable portion is excluded from income. California can "look back" up to four years for back taxes filed; therefore, you should keep your settlement records for at least four years.


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