California is no stranger to wildfires. Over many years, numerous fire victims have suffered losses and hope to recover funds via insurance and from lawsuits. Fire victims are often surprised at the significant income tax consequences they encounter, both in sheer complexity and in the often surprising tax treatment they face on their proceeds.
Federal Tax Exemption
For fire victims in federally declared disasters, the skies parted in late 2024 with a broad federal tax exemption to make wildfire settlements tax free if received in 2020 through 2025. Yet even that tax relief provision includes puzzling qualifiers that exclude many recoveries. The federal law is also sunsetting at year end, so unless it is extended by Congress, it will be of no help to the legions of fire victims who expect to eventually recover from defendants in 2026 and ensuing tax years.
California Tax Exemption
But what about California tax law? California passed a series of fire specific wildfire exemptions so that at least some recoveries are free of California tax, but these rules were spotty and they omitted numerous fires and fire victims. As more tax bills were introduced, on September 29, 2024, Governor Newsom vetoed two additional bills that would have granted state-level income tax exclusions to certain wildfires. The Governor explained that he vetoed the bills, not because he disagreed with the idea that recoveries should be tax-free, but because he believed that a wildfire exclusion should be addressed more systematically as part of the annual budgeting process, not on a wildfire-by-wildfire basis.
Finally, in 2025, S.B. 132 was enacted to add a new section to the California tax code, Section 17138.7. This Section covers most types of California taxpayers, but C corporations are covered by a similar exclusion in Section 23409.2 The new exclusion has requirements, but unlike previous California exclusions for specifically named wildfires, this new California exclusion is broad. It applies to all qualifying wildfire recoveries received by a California taxpayer between January 1, 2021, and December 31, 2030.
Unfortunately, as originally enacted, to be excludable, the qualifying recovery must be received from a “settlement entity.” The new law originally defined “settlement entity” to mean an entity “approved by a class action settlement administrator.” On the surface, that omitted thousands of fire victims who received recoveries in standalone lawsuits against utilities. If the payout was from a single defendant and not part of a class action, they would not be covered by the new California law.
Quick Clarification of New Law
Fortunately, shortly after it was enacted, Section 17138.7 and the corresponding exclusion for C corporations in Section 23409.2 were amended to broaden their exclusion. The amendment removes the class action settlement administrator reference and covers amounts received in direct settlement with a defendant, via a settlement entity like the PG&E Fire Victim Trust, or via a class action settlement. All should qualify if the other requirements in Section 17138.7 are met. Although the amendment to the “settlement entity” language broadened the exclusion, another revision to Sections 17138.7 and 23409.2 arguably narrowed it.
The original language to these sections seemed to include any wildfire as a qualifying wildfire for the purposes of the exclusion, without defining what would be considered a wildfire. However, the amended language now requires that a qualifying wildfire be either a federally declared disaster that is the subject of a federal major disaster declaration or a federal emergency declaration or a wildfire that was the subject of a proclamation of a state of emergency by the California governor.
This seems more restrictive than the previous undefined reference to all wildfires. However, it is not clear how many major California wildfires will be affected by the revised language. Most of the largest recent California wildfires are the subject of a federal major disaster declaration or emergency declaration (or both). For the wildfires that did not qualify for federal major disaster declarations or emergency declarations, all of these that we have seen in our practice to date have been the subject of a Proclamation of a State of Emergency by the governor.
For example, some fires that should qualify for the California exclusion based on a California emergency declaration include the 2018 Holiday Fire, 2020 Mountain View Fire, and 2022 Mosquito Fire, despite their not having received either of the two required types of federal disaster declaration. Therefore, for most California wildfire victims, the clearer definition of a qualifying wildfire may not impact their ability to qualify for the new exclusion, and instead, should make it easier to satisfy.
Beware the Expiration Dates
Turning to federal taxes, most of the attention may be on the federal exclusion for certain wildfire recoveries. Sadly, the federal exclusion will sunset at the end of this year, unless it is extended. In contrast, the California exclusion will apply through the end of 2030 for most taxpayers. The California exclusion is also highly relevant for taxpayers who do not qualify for the federal exclusion. The California-specific exclusion in the recently enacted—and then even more recently amended—Sections 17138.7 and 23409.2 provides important and welcome tax relief to California wildfire victims.