The incident happened last year when Kirsty Powell and her husband were pulled over by police for driving a "low rider" car, according to the lawsuit.
Ms Powell was arrested after police found a warrant under her name for a shoplifting incident, CNN reported.
Ms Powell's husband requested a female officer to handle the arrest, but the arresting officers denied the request and told Ms Powell that she had to remove her hijab. Ms Powell spent the night in prison without her headscarf. It was returned when her husband posted her bail bond, the report said.
Ms Powell filed the lawsuit in April 2016, alleging the police department had violated her First Amendment rights.
Ms Powell was "forced to appear in a publicly available booking photo without her religious headwear," the lawsuit said.
"As a result of the foregoing, deprivations of the free exercise of her religion, Kirsty Powell suffered severe discomfort, humiliation, and emotional distress," it said.
The city of Long Beach, California, will pay USD 85,000 to settle the lawsuit filed by Powell.
The Council on American-Islamic Relations announced the settlement and praised Powell.
Powell had told the Council on American-Islamic Relations when she filed the suit she wanted to be the last Muslim woman who has this experience.
"I want my Muslim sisters to always feel comfortable and safe wearing a hijab and to stand up for what's right," she said.