Rev. Rul. 83-51: Are Wrongful Death Settlements Taxable?

When a family receives a settlement for a wrongful death claim, a common question is whether that money is taxable. Generally, these awards are not considered taxable income to the surviving family members. Federal tax law recognizes that the money is intended to compensate for the loss stemming from a death, rather than representing a form of income or financial gain.

The Core Principle of Tax Exclusion

The tax-free nature of wrongful death awards is rooted in federal tax law, specifically Internal Revenue Code Section 104. This section of the tax code excludes from a taxpayer’s gross income any damages received on account of personal physical injuries or physical sickness.

Although the wrongful death claim is brought by the survivors, the law extends this protection to them because the claim originates from the physical injury that caused the decedent’s death. Therefore, the payments made to the family are treated as being “on account of” that initial physical harm. This interpretation links the survivors’ financial recovery to the physical injury suffered by their loved one.

This principle ensures that the financial award is not diminished by federal income taxes. The tax code recognizes the compensatory purpose of these funds, distinguishing them from wages, investments, or other forms of taxable income.

Non-Taxable Components of a Wrongful Death Award

A wrongful death settlement is typically composed of several distinct elements, the majority of which are considered compensatory and not subject to income tax. One of the largest components is the recovery for loss of financial support. This represents the earnings and other economic contributions the deceased would have provided to the family.

Another non-taxable component is compensation for the loss of companionship, consortium, or parental guidance. These damages acknowledge the personal loss of relationship suffered by the surviving spouse, children, or parents. Any amount specifically allocated to reimburse for funeral and burial expenses is not taxable.

In cases where a “survival action” is brought on behalf of the decedent’s estate, damages for the deceased’s own pain and suffering before death may be recovered. These awards are paid to the decedent’s estate, not directly to the family. As part of the estate, these funds may be subject to federal or state estate taxes and must pass through the probate process before being distributed to heirs. The settlement agreement should specify the allocation to each of these non-taxable categories.

Taxable Elements in Wrongful Death Cases

While the core of a wrongful death award is non-taxable, certain elements are identified by the IRS as taxable income. The most prominent of these are punitive damages. Unlike compensatory damages, punitive damages are awarded to punish the defendant for egregious or reckless behavior and to deter similar conduct. Because they do not compensate for a specific loss, they are considered taxable income. A narrow exception exists if the applicable state law in effect on September 13, 1995, provided that only punitive damages could be awarded in a wrongful death action.

Interest accrued on the settlement or judgment is another taxable component. This can include both pre-judgment interest, calculated from the time of death to the date of the judgment, and post-judgment interest, which accumulates until the award is paid. This interest is considered investment income and is reported on Schedule B of Form 1040, after the recipient receives a Form 1099-INT from the payer.

A third taxable situation arises under the “tax benefit rule.” If the family previously deducted medical expenses related to the deceased’s final injury on a prior year’s tax return, any portion of the settlement that reimburses those deducted expenses must be included as income. This rule prevents a double tax benefit. The amount to be included as income is limited to the extent the original deduction reduced the taxpayer’s tax liability.

Reporting and Documentation Requirements

Properly handling the tax implications of a wrongful death settlement begins with understanding what to report to the IRS. The main, non-taxable portion of the award, which includes compensation for losses like financial support and companionship, does not need to be reported on your tax return.

For the taxable portions, specific reporting is required. Interest income must be reported on Schedule B (Form 1040), Interest and Ordinary Dividends. Any taxable punitive damages are reported as “Other Income” on Schedule 1 (Form 1040). If the tax benefit rule applies to recovered medical expenses, that amount is also included on Schedule 1.

The settlement agreement is the most important documentation for tax purposes. This legal document should clearly allocate the total award among the different categories of damages. A well-drafted agreement provides the primary evidence to support your tax position if the IRS questions the allocation. Keep a copy of the final settlement agreement with your permanent tax records.