When you get hurt in an accident, the last thing you are thinking about is taxes. However, how the case will affect your taxes is something you and your lawyer should consider before accepting a settlement.
Generally, any money paid to reimburse you for a physical injury is not taxable. This is the rule for both NJ and federal taxes. That means that money paid because of your physical injury – such as medical bills, lost wages, and pain and suffering – are tax-exempt. However, damages paid for a mental-only injury are taxable, as are other money you receive in a lawsuit, such as punitive damages and interest.
For help with your case, call Agrapidis & Maroules, P.C.’s NJ personal injury lawyers at (201) 777-1111.
Are Damages from a Personal Injury Lawsuit Taxable?
Under both federal and state law, you are not taxed on most of the damages from a personal injury lawsuit. More specifically, anything attributed to a physical injury is not taxed. That includes…
- Medical bills
- Lost wages
- Pain and suffering from a physical injury
- Other economic damages paid because of a physical injury.
However, some parts of the claim are not paid because of the injury.
Parts of a Personal Injury Claim that Are Taxed
The following damages are often paid in a personal injury case, but they are not paid because of the physical injury. As such, they may be taxed as part of your total income for the year:
- Punitive damages – These are paid to punish the defendant, not to reimburse you for anything.
- Liquidated damages – If a statute or agreement lists a certain amount to be paid, these are generally treated as punishing the defendant, not reimbursement for your injury.
- Interest – Interest paid on the damages is taxable as income.
Many of these damages are still very important, and your NJ personal injury lawyer should always seek to include them in your case (when relevant), even though they might be taxable.
Are Lost Wages from an Injury Claim Taxable?
This is an incredibly confusing rule for many people, given that the IRS discusses all kinds of lawsuits when it comes to the rules for lost wages. In various IRS documents and rules, you can see the rules for personal injury cases alongside the rules for things like wrongful termination lawsuits, but they are taxed differently.
Lost Wages from Physical Injury
Again, like the general rule says: if your damages are paid because of a physical injury, the damages are not taxable. This includes portions allocated to lost wages.
This rule is found under Internal Revenue Code § 104(a)(2), which excludes all damages paid because of a physical injury or illness. This rule was further confirmed under Commissioner v. Schleier (1995) and a 1999 IRS Ruling that confirmed that lost wages in a personal injury are excluded.
Mental-Only Injury
If your lost wages are paid because of a mental-only injury, they may be taxable. This could come up in a claim for emotional distress without a physical injury, but those cases are rare. If that happens, your lost wage damages would be taxable.
Other Claims
If you have any other kind of “injury”, such as wrongful termination or retaliation, then the damages paid in those cases are not because of a physical injury. That would make them taxable.
Is Pain and Suffering Taxable?
Pain and suffering is confusing because it is not taxed if it is from a physical injury, but it is taxed if it is from a mental-only injury.
Mental-Only Suffering from Other Cases
When the tax code refers to a mental injury, they are often referring to things like the shame of wrongful termination or the embarrassment of a libel lawsuit, and they are not talking about personal injury lawsuits. Those damages would be taxed.
Pain and Suffering from a Physical Injury
As long as there is a physical injury that caused the pain and suffering, you are not taxed on these damages. This includes tax-free payment for mental anguish, emotional distress, or other non-economic damages, whatever they are called.
Mental-Only Injuries
However, if you do suffer a mental-only injury – such as emotional distress from witnessing a loved one killed in a car crash – then you might have to pay taxes on those damages.
Are Settlements vs. Jury Awards Taxable?
It generally doesn’t make a difference if the damages you receive are ordered by a jury or paid as part of a settlement. In both cases, the money you receive for a physical injury is tax-free. This is included specifically in the text of I.R.C. § 104(a)(2).
Structured Settlements
However, there is something to take into consideration: while your income might not count for tax purposes, it might count as “income” when qualifying for other programs. For example, SNAP benefits, Medicaid, and ACA health insurance plans might all require income and assets under certain levels.
If you structure your settlement properly, you may be able to keep your eligibility for these programs, whereas receiving all of the money in one lump sum might mean you have too much income that year to qualify.
FAQs for Taxing Injury Settlements in NJ
Are Personal Injury Damages Taxable?
When you get payments for a physical injury, they are not taxed. This includes all compensatory damages to pay you for your injury, both economic and non-economic.
Is the Portion of a Settlement for Lost Wages Taxable?
Many people think that the portion allocated to lost wages would be taxed because it is merely a replacement for the wages you lost, which would normally be taxable. If the lost wages are paid because of a physical injury case, then they are excluded from taxable income under I.R.C. § 104(a)(2).
How Are Portions of My Settlement Taxed?
If some portion of your settlement is taxable – such as punitive damages – you calculate taxes by including it in your income for the year. High payouts might lead to high tax liabilities in certain years, so it is often a good idea to structure your settlement to lower your tax burden.
What if I Took a Tax Deduction for Damages in Previous Years?
If you took a tax deduction for something like medical care to pay for your physical injury case, then you might have to pay taxes on it in the year you receive compensation to make up for that previous deduction.
This is complicated and you should always have a tax lawyer review your case.
Do I Need a Tax Lawyer?
Even if you have discussed the tax implications of your injury claim with your personal injury lawyer, you should still consider talking to a tax lawyer or CPA about your case as well. Personal injury lawyers are not tax experts.
Call Our NJ Personal Injury Attorneys Today
For a free case review, call Agrapidis & Maroules, P.C.’s Jersey City, NJ personal injury lawyers at (201) 777-1111.