If you’ve received or expect to receive a personal injury settlement, one of the first questions that probably comes to mind is:
“Will I have to pay taxes on it?”
It’s a smart question — and the answer depends on what the settlement money is for.
The good news is that in most cases, you will not owe federal or New Jersey state income tax on money you receive for physical injuries.
Let’s break down exactly how it works.
The General Rule: Physical Injury Settlements Are Not Taxable
Under IRS Rule 26 U.S. Code § 104(a)(2), compensation for physical injuries or physical sickness is not considered taxable income — whether it comes from a settlement or a jury verdict.
That means if you were injured in a:
- Car accident,
- Slip and fall,
- Workplace injury (non–workers’ comp), or
- Any case involving bodily harm,
and your settlement compensates you for medical bills, pain and suffering, or permanent disability, that portion of the recovery is tax-free.
In short:
If your injury was physical, your settlement for that injury is generally not taxable.
What Parts of a Settlement Can Be Taxed
While most personal injury compensation is tax-free, there are a few exceptions. The key is what the money is meant to replace.
Here’s how the IRS views it:
1. Lost Wages or Lost Income
If part of your settlement compensates you for the wages or salary you would have earned if you weren’t injured, that portion can be taxable — because wages normally would have been taxed.
Your attorney can often help structure the settlement so that these amounts are clearly separated for reporting purposes.
2. Interest on the Settlement
Sometimes settlements include interest, especially if the case took a long time to resolve. Interest is considered taxable income by the IRS.
3. Emotional Distress Without a Physical Injury
If you receive money for emotional distress or mental anguish not linked to a physical injury (for example, a discrimination or defamation case), the IRS generally taxes that portion.
However, if your emotional distress stems from a physical injury — such as trauma after a car crash — it’s usually not taxable.
4. Punitive Damages
Punitive damages, which are designed to punish the wrongdoer rather than compensate you, are taxable under federal law.
They are relatively rare in standard personal injury cases but may appear in cases involving gross negligence or intentional harm.
What About Medical Expense Deductions?
If you previously deducted medical expenses related to your injury on your tax return — and later got reimbursed for those expenses through a settlement — that portion may be taxable to prevent “double-dipping.”
Your accountant can help determine if this applies to you.
New Jersey State Taxes
New Jersey generally follows the same federal rules:
- Settlements for physical injuries are not subject to state income tax.
- Portions for lost income, punitive damages, or interest are taxable.
If your case is settled or tried in New Jersey, the same basic tax principles will apply.
How Your Attorney Helps You Handle Taxes Properly
An experienced personal injury attorney doesn’t just fight for maximum compensation — they also help structure your settlement correctly to avoid tax issues later.
That means:
- Separating non-taxable and taxable components,
- Clearly identifying what each payment represents in the settlement agreement, and
- Coordinating with your accountant or tax professional if needed.
The clearer your documentation, the easier it is to show the IRS that your settlement should not be taxed.
Example: A Typical Auto Accident Settlement
Let’s look at a simple example:
Jane was injured in a car crash and settles her case for $250,000.
Her settlement includes:
- $200,000 for medical bills, pain, and suffering (non-taxable)
- $40,000 for lost wages (taxable)
- $10,000 in interest (taxable)
Jane would only owe taxes on $50,000 of the total — not the full settlement.
This is why understanding what each part of your settlement represents is so important.
Key Takeaway
For most people injured in car accidents, slip and falls, or other negligence cases, personal injury settlements are not taxable.
However, parts of the settlement that represent lost wages, punitive damages, or interest may be taxable — and those amounts should be clearly separated in your settlement paperwork.
Always review your settlement with a personal injury attorney and a tax professional before filing your return to make sure you’re in compliance and not overpaying taxes you don’t owe.
Have Questions About a Settlement or Upcoming Case?
If you’ve received a personal injury settlement — or are expecting one — and want to understand the financial and tax impact, our law firm can help.
We’ll explain how your compensation is structured, what’s taxable (and what isn’t), and make sure you’re fully protected before tax season arrives.
