Do You Pay Taxes on a Wrongful Death Settlement?

Understanding Wrongful Death Settlements

A wrongful death claim arises when an individual’s death is caused by the negligence, recklessness, or intentional act of another party. These legal actions are distinct from personal injury claims because they are brought by the deceased person’s survivors or estate, rather than the injured individual themselves. The purpose of such a claim is to seek financial recovery for the losses incurred by the family due to the untimely death.

Those eligible to receive a wrongful death settlement include the surviving spouse, children, and parents of the deceased. Other dependents or close family members may also be designated as beneficiaries, depending on state laws. These settlement funds provide financial stability and compensation for damages suffered by the family.

Wrongful death settlements cover economic and non-economic losses. Economic damages include medical expenses incurred by the deceased before passing, and funeral and burial services. They also cover the loss of the deceased’s expected future income and financial support they would have provided to their family.

Settlements also address non-economic damages. They include compensation for the loss of companionship, care, protection, and guidance that the deceased would have offered to their family members. Some jurisdictions include compensation for the pain and suffering experienced by the deceased prior to their death.

General Tax Treatment of Wrongful Death Settlements

The Internal Revenue Service (IRS) does not subject a wrongful death settlement to federal income tax for beneficiaries. This non-taxable status is based on the principle that these settlements are compensation for personal physical injuries or sickness.

Under federal tax law, Internal Revenue Code Section 104 states gross income does not include damages, other than punitive damages, received on account of personal physical injuries or physical sickness. Compensation received for losses directly resulting from the physical injury that caused the death is excluded from taxable income.

This general rule applies whether the settlement funds are received as a single lump sum payment or as a series of periodic payments over time. This general exclusion covers damages for lost wages, medical expenses, and emotional distress directly related to the physical injury or sickness that caused the death.

Specific Taxable Components

Certain components of a wrongful death settlement can be subject to taxation.

Punitive damages are taxable as ordinary income. They are awarded to punish the wrongdoer for egregious conduct. Because their purpose is not to compensate for a physical injury, the IRS considers these amounts taxable income.

Any interest earned on the settlement proceeds is taxable. This includes interest that accrues from the date the lawsuit was filed until the settlement is received. If settlement funds are held in an interest-bearing escrow account, any interest earned on those funds is taxable income.

Emotional distress not directly attributable to a physical injury or sickness could be taxable. If a settlement explicitly separates and compensates for emotional distress unrelated to the physical injury, that portion is taxable.

Documentation and Record-Keeping

Maintaining comprehensive documentation is important. These records serve as evidence of the settlement’s nature and allocation.

Key documents to retain include the official settlement agreement, which outlines the terms and amounts. Any court orders or judgments related to the claim should be kept.

Legal invoices that detail attorney fees and other legal expenses should be retained. Documentation that specifically allocates the settlement proceeds among different types of damages, such as lost income, medical bills, or punitive damages, is valuable.

Bank statements showing the deposit of the settlement funds and any interest earned on those funds should be kept. Beneficiaries should consult with a qualified tax professional or financial advisor.

Conclusion

Wrongful death settlements provide financial recourse to families who have lost a loved one due to another’s negligence. These settlements aim to address the losses experienced by survivors. Understanding the financial aspects, including tax implications, can provide clarity during a difficult time. The focus of these settlements is to help beneficiaries navigate financial challenges after the unexpected death of a family member.