Generally speaking, any income you earn is subject to tax at the federal and state levels. New Jersey's state tax laws define income much the same as the IRS does. Taxable income includes income from sources that include wages, profits, net gains and interest. A legal settlement may have taxable and non-taxable portions, depending on how those damages are classified.
Recovery of Out-of-Pocket Expenses
New Jersey does not take taxes from settlement amounts intended to compensate you for expenses you incurred treating physical or mental injuries, such as medical bills. However, if you've already deducted those medical bills to lower your tax liability in a previous year, reimbursement of those expenses is considered taxable income. Similarly, money that reimburses you for property damage is not taxable, unless you've realized a profit because the settlement amount was greater than the value of the damaged property.
Punitive Damages and Interest
Your settlement may include punitive damages, which are intended to punish a company or individual that has violated your rights or harmed you in some way. New Jersey always considers punitive damages to be taxable income. Any interest added to any portion of your settlement also is taxable income.
Compensation for Non-Physical Injuries
Money intended to compensate you for emotional distress you suffered as a result of a physical injury or illness is not taxable income in New Jersey. However, if you suffer emotional distress as a result of something other than a physical injury, any money you receive for that is taxable income. This situation arises if, for example, you are suing your employer for racial discrimination. Any damages you get for emotional distress in such a case would be taxable income.
Back Pay or Lost Wages
If your settlement includes back pay, such as if you lost work as the result of an injury and filed a workers' compensation suit against your employer, that amount is taxable income. New Jersey considers back pay as taxable at the same rate it would have been if you had received it while working. However, if you receive compensation for lost wages directly related to a physical injury from someone other than your employer, the income is not taxable. For example, if you were in a car accident and sued the driver of the other car, your settlement may include a portion to compensate you for lost wages while you were recovering from your injuries in the hospital. Those lost wages would not be taxable income in New Jersey.
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