Good news for California residents who have received settlements from the PG&E Fire Victims Trust (FVT) or the Southern California Edison Settlement. Last night, both houses of the California legislature passed AB1249 and SB1246 and the Governor is expected to sign them.

This bill excludes the settlement money from gross income for California income tax purposes. This treatment is available to victims of the 2015 Butte Fire, the 2017 North Bay Fires, the 2018 Camp Fire, the 2017 Thomas Fire, 2018 Woolsey Fire.

Note this is for California income tax ONLY. Your settlement may still be partially or fully taxable for Federal Tax purposes. If you are not a California resident, your settlement may still be taxable to your resident state.

To get more information about the Federal Taxability of your settlement please see our earlier posts on this topic and contact a tax professional.

On March 30, 2022, bipartisan legislation was introduced to make the PG&E payments non-taxable at the Federal level. This bill was just introduced and has a LONG way to go to get approved. Here is the Press Release from Mike Thompson’s office (CA-05).

There is similar legislation in the California legislature that would make the payments non-taxable for California purposes. See the story HERE. The California bill has been approved by the Assembly and is awaiting a Senate vote so this bill is much further down the road than the Federal one. Word on the street is that the State Senate will vote in May 2022 on this bill.

What should you do about your taxes?

• Many practitioners are having their clients file extensions for 2021 and paying the full amounts that could be due to the Feds and the State.
• Then once the legislation gets passed, the real return will be recalculated and filed and hopefully the client will be due a refund.

As we’ve discussed in earlier posts on this site, for most taxpayers, the settlements from PG&E will be partially or fully taxable. However, relief from California tax may be coming.

AB1249 passed the assembly last week and is going to the State Senate for review. If this bill passes, it would exclude the PG&E settlement money from gross income for California income tax purposes (Note: it would still be taxable to the Feds). This treatment would be awarded to victims of the 2015 Butte Fire, the 2017 North Bay Fires, and the 2018 Camp Fire.

This bill stalled in the assembly for almost a year, so it is unclear if it will actually pass or not. But if you are going to be eligible for this exclusion, you may want to wait to file your 2021 California Income Tax Return.

We previously discussed the taxability of the PG&E settlements that many fire victims are receiving (See, Is My PG&E Settlement Taxable? from August 3, 2021). We received a few questions recently:

Q1: I received a payment of 30% of the total award that is due to come to me. How do I allocate that award?

A1: Most taxpayers have received the worksheets from the Fire Victims Trust (FVT) that shows the details of the award. So, if you receive a payment for 30% of the total award, then you should allocate it across the award categories shown in the worksheets.

In addition, the FVT has stated that preliminary payments are meant to represent a pro rata allocation of the expected approved claim.

If the settlement agreement is silent as to the allocation (Or you decided not to get the worksheets from the FVT that show the allocation) then the amount received should be allocated based on the claim for damages.

(Knuckles v. Commissioner; Threlkeld v. Commissioner).

Q2: I understand how the Feds tax the award. Does California tax it the same way?

A2: Yes, in general California conforms to the Federal treatment of gross income under IRC 61. (CA RTC 17071)

Q3: How do I handle the attorney fees paid to obtain an inverse condemnation award?

A3: Legal fees paid to litigate/obtain a condemnation award are offset against the amount of the award and thus reduces the amount realized and thus the amount that needs to be reinvested to get full gain deferral under IRC 1033. (Rev. Rul. 71-476).

E.g. Taxpayer received a condemnation award of $500,000. They paid $150,000 in attorney fees to get the condemnation award. So, $500,000 – $150,000 = $350,000 that is considered the amount realized from the condemnation. This amount will be included in the overall calculations to determine if the taxpayer has a gain on the casualty.

(Author’s note: This does not mean that all of your attorney fees are treated this way. Only a specific subset of your fees related to a condemnation award).

Q4: What if I took a loss on my 2017 tax return and now that I am receiving PG&E money, I no longer have a loss?

A4: Under the tax benefit rule, the excess is included in income in the year received to the extent of the tax benefit received in the earlier year. (Treas. Reg. 1.165-1(d)(2)(iii) and Mager v U.S.).

(Author’s note: This calculation always hurts my head and I do taxes all year long. So, it may not be something the lay person wants to tackle).

If you are receiving money from the PG&E fire settlement the award may be taxable to you.

In general, all income is considered taxable unless Congress says it is not (IRC 61). So, when we look at your PG&E settlement offer, we start with the presumption that all of it is taxable and then we walk through the Internal Revenue Code to try and find ways to make it not taxable.

What the Award is For

First, you have to determine what your award is for. The PG&E Fire Trust has been providing worksheets that detail all the part of your settlement award (e.g. Emotional Distress-Nuisance, Emotional Distress-Zone of Danger, Personal Injury, Real Property, Interest, etc). If you receive a lump sum amount with no details then you can ask your attorney for the detailed worksheets. If there are no worksheets available, you have to go back to the original complaint and allocate the award against the complaint.

Is It Income

Next you have to determine whether each part is includable or excludable from income. Some common settlement elements are:

• Physical Injury (IRC 104) – payments for physical injury or sickness are excludable from income, but the injury must be physical meaning there was bodily harm.
• Emotional Distress (IRC 104) – payments for emotional distress are includable in income unless the emotional distress is a result of the physical injury. If you have a physical injury as a result of emotional distress that would still be included in income — the bodily harm must happen first to exclude it.
• Property Settlements – payments for your real property/contents could be excludable as a disaster relief payment if you rebuild (IRC 139), or you may be able to exclude some of the gain by taking a personal residence exclusion (IRC 121), or you could defer the gain by meeting the requirements of an involuntary conversion (IRC 1033). (Note: Involuntary conversions have specific rules and timelines and the timelines could be tight, especially for Tubbs fire victims).
• Interest – interest is taxable

Deducting Attorney Fees

Most of the PG&E fire lawsuits are contingent fee lawsuits which means that the attorney fees cannot be excluded from the gross award (Comm v Banks). So, if you receive $100,000 and give 25% to your attorney, you are still taxed on the full $100,000. Further, the Tax Cuts and Jobs Act eliminated the tax deduction (IRC 67) for attorney fees through 2025, so there is no deduction available for the attorney fees on your Federal Income Tax Return (attorney fees are still deductible on the California Return).

Some exceptions are:

• If part of your award is determined to be non-taxable (e.g. under IRC 139) then a pro rata share of the attorney fees would also be non-deductible on the CA return.
• If part of your award receives capital gain treatment then a portion of the attorney fees can be added to the basis of the property and thus will be deductible (United States v. Hilton Hotels Corp).

This can be a very complex tax situation thus we recommend you hire a competent professional to help you.