Quick Hits

• If an employee is awarded or agrees to legal costs or attorneys’ fees as a result of a case or informal claim of unlawful discrimination, retaliation, or a whistleblower action, those amounts would not be subject to New Jersey state income tax under legislation (AB 5485) introduced in the Assembly.
• AB 5485 would not alter the taxation of other components of settlements or monetary awards (e.g., back pay).
• If enacted, the bill would apply to taxable years beginning on January 1 of the year following the date of enactment.

Assembly Bill (AB) 5485 was introduced on September 14, 2026, and has been assigned to the New Jersey Assembly Judiciary Committee. It would apply to awards of legal costs and attorneys’ fees in cases or claims involving unlawful discrimination, retaliation, wrongful discharge, breach of contract, or unpaid wages, severance, or overtime. It also would apply to monetary awards a state taxpayer received under the federal False Claims Act or the New Jersey False Claims Act. However, other types of awards, such as back pay, settlement money, general damages, and punitive damages, remain fully taxable.

In 2004, the U.S. Congress passed the federal Civil Rights Tax Relief Act, which permits taxpayers to deduct from federal income taxes the attorneys’ fees and legal costs awarded in unlawful discrimination, retaliation, or whistleblower claims. Previously, in some cases, taxpayers had to pay income taxes on attorneys’ fees they never received because the fees were paid directly to the attorneys out of a judgment award or settlement agreement. The New Jersey bill aims to conform state law with the Internal Revenue Code to address that situation.

Next Steps

If enacted, the bill would apply to taxable years beginning on or after January 1 of the year following the date of enactment.

Employers in New Jersey may wish to coordinate with their third-party payroll vendor to ensure compliance with tax reporting and tax withholding obligations when an employee receives settlement money, legal costs, attorneys’ fees, back pay, or monetary damages.