There’s a famous phrase often attributed to Benjamin Franklin: only two things in life are certain—death and taxes. If you’ve been in a car accident in the U.S., you’re likely facing significant expenses. Filing a compensation claim can help cover those costs. But that raises an important question: Are car accident settlements taxable? In California, as of 2025, most of the personal injury settlements are tax-free.
While the core damages related to physical injuries—such as medical bills, pain and suffering, lost wages directly resulting from physical harm, and property damage up to its actual value—remain non-taxable under both federal law and California’s corresponding tax code, any interest awarded is not exempt. This interest must be reported as ordinary income on both your federal and state tax returns.
In this article, we’ll offer a clear breakdown of which parts of your arrangement are taxable (or not); how much money actually ends up in your pocket, and how California car accident lawyers can help you maximize your payout. If you have specific questions about your car accident, call (866) 359-0807. Megeredchian Law offers free consultation 24/7 and gives you direct access to an attorney.
Are Car Accident Settlements Taxable? Which Parts?
What (Might Be) Taxable
It’s important to clarify that every settlement is different, and unfortunately, there are no clear-cut answers to the question: “Are car accident settlements taxable?” The specific circumstances of your car accident—and the reasons you received compensation—are fundamental in determining whether any part of your settlement is taxable in California.
Having a tax consultant on your side is highly advisable. If you don’t have one, consider asking your attorney for guidance on how to handle the tax implications of your settlement. That being said, some of the parts of your car accident settlement that might be taxable in California are:
Lost Wages
In California, compensation for lost income received as part of a car accident settlement is generally considered taxable under both federal and state law. This is because it serves as a replacement for wages you would have otherwise earned, which are subject to income tax. As a result, the IRS and the California Franchise Tax Board typically require you to report this portion as ordinary income on your tax return.
If your settlement clearly designates a specific amount for lost wages—supported by evidence such as pay stubs or employer documentation—this portion is almost always taxable. This is especially true in employment-related cases, such as those involving back pay or wrongful termination, where lost income is a central component of the damages.
In addition to income taxes, compensation for lost wages may also be subject to payroll taxes like Social Security and Medicare. Therefore, it’s important to review how your settlement is structured to understand the full tax implications of the income-related portion.
Interests
Any interest paid as part of a personal injury settlement in California is generally subject to taxation. In cases where settlement payments are delayed, courts may award prejudgment or postjudgment interest, which is added to the final compensation amount. Under both federal law (per IRS guidelines) and California’s Franchise Tax Board, such interest is treated as taxable income because it compensates for delay—not for physical injury.
Real-life Example
Maria settled her 2023 Los Angeles car accident lawsuit in late 2024 for a total of $100,000, which included $80,000 for medical expenses, pain and suffering, and lost wages, plus $20,000 in prejudgment interest due to delayed payment.
Under both federal law (IRC § 104(a)(2)) and California’s conforming rules, the $80,000 for physical-injury damages remained non-taxable, while the $20,000 of interest was treated as ordinary income.
When Maria filed her 2025 tax return, she reported the $20,000 in interest as taxable income to both the IRS and California’s Franchise Tax Board. Reviewing her settlement agreement with legal and tax advisors ensured she understood that only the interest portion, not the injury-related damages, would be subject to taxation.
Punitive Damages
In California, when a personal injury case results in punitive damages, those amounts are usually considered taxable. Unlike compensation for medical costs or emotional distress, punitive damages are awarded to penalize the wrongdoer for extreme misconduct and to discourage others from acting similarly. Because they aren’t tied to the victim’s direct losses, the IRS and California tax authorities classify them as income that must be reported on your tax return.
Real-Life Example
In 2022, a jury in California awarded a plaintiff $1 million in a personal injury lawsuit stemming from a drunk driving accident. Of that amount, $750,000 was for medical expenses, lost wages, and pain and suffering—compensatory damages tied directly to the injuries sustained. The remaining $250,000 was awarded as punitive damages due to the defendant’s repeated history of DUIs and reckless behavior.
When the plaintiff filed taxes for the year the settlement was received, the $750,000 in compensatory damages was not taxable under federal or California law because it was related to physical injuries. However, the $250,000 in punitive damages was fully taxable and had to be reported as income. The plaintiff’s tax advisor prepared a return reflecting that portion, ensuring compliance and avoiding penalties.
Pain and Suffering Damages Not Caused by the Accident
While pain and suffering are usually not taxable, emotional distress or mental anguish damages can be if they are not directly caused by a physical injury. According to federal and California tax law, compensation for emotional harm is considered taxable income unless the distress stems from a physical injury or physical sickness.
If the emotional distress is due to other factors—such as the trauma of the legal process, reputational damage, or stress unrelated to bodily harm—it must be reported as income on both federal and state tax returns.
Real-Life Example
A woman involved in a minor car accident in California receives a $100,000 settlement. Only $10,000 covers medical bills for a soft tissue injury, while $90,000 is allocated to emotional suffering and anxiety she developed several months later, which were not clearly tied to her physical injury. In this case, the $90,000 would likely be taxable, because the mental anguish was not directly linked to the physical harm sustained in the crash.
Out-of-Pocket Expenses You Claimed Before the Settlement
While most out-of-pocket expenses recovered in a car accident settlement are not taxable, an exception applies if you previously deducted those medical expenses on your tax return. In that case, the reimbursed amount may be considered taxable income, since you already received a tax benefit for them before the settlement.
Real-Life Example
Imagine you were injured in a car accident in 2023 and paid $5,000 out of pocket for medical treatment. You itemized your deductions and claimed that $5,000 on your 2023 federal tax return, reducing your taxable income. In 2025, you receive a settlement that includes reimbursement for those same medical expenses. Because you already received a tax benefit in 2023, the IRS (and California tax authorities) may require you to report that $5,000 as taxable income in 2025.
This is known as the “tax benefit rule”, which prevents individuals from receiving a double tax advantage on the same expense.
What is Not Taxable
Medical Expenses (past and future)
- Not taxable if directly related to a physical injury.
- Reason: Treated as reimbursement for actual medical costs.
Pain and Suffering (tied to physical injury)
- Not taxable when connected to a physical injury or illness.
- Reason: Considered non-economic damages restoring your well-being, not income.
Emotional Distress (from physical injury)
- Not taxable if it stems directly from a physical injury.
- Reason: Follows the same federal and state guidelines as pain and suffering.
Property Damage (up to cost basis)
- Not taxable if the compensation equals or is less than the damaged property’s original value.
- Reason: Treated as reimbursement, not a gain.
Structured Settlements (for physical injury or sickness)
- Not taxable if set up under a qualified structured settlement agreement.
- Reason: Federal tax law (IRC § 104(a)(2) and § 130) exempts these payments.
Legal Fees (when paid from non-taxable damages)
- Not taxable if fees are paid from parts of the settlement that are themselves not taxable.
- Reason: The tax treatment follows the character of the underlying settlement funds.
How Much Do I Get from My Car Accident Settlement, After Taxes?
How much you take home from a car accident settlement in California after taxes depends on how the settlement is structured. In most cases, the bulk of a personal injury settlement—such as compensation for medical expenses, pain and suffering, and property damage—is not taxable under federal or California state law. These portions are viewed as reimbursement for actual losses, not income.
Ultimately, the final amount you keep depends on how the settlement agreement is worded and whether your compensation includes taxable elements. To maximize your net recovery and avoid unexpected tax liability, consult with experienced California car accident lawyers who understand how to structure your settlement effectively. Call Megeredchian Law at (866) 359-0807 to speak with an attorney directly.