Taxation of your wrongful death settlement is a complicated matter. While you have already made it through the bulk of your claim, you and your family will still have to deal with state and/or federal tax responsibilities. After losing someone close to you, taxes are the last thing you will want to worry about. You can work with a wrongful death lawyer to make organizing your settlement and paying taxes easier.
Will Your Settlement Be Taxed? Yes and No
The short answer is that you may have to pay taxes on some parts of your wrongful death settlement, but not other parts. For example, most wrongful death settlements in California are nontaxable. Unless your case qualifies as an exception, you will not have to pay any taxes on the money you receive from a defendant for your loved one’s avoidable death. The Internal Revenue Service (IRS) typically will not take taxes from a wrongful death settlement or court-ordered judgment award.
An important exception to note, however, is that while the IRS will not tax compensatory damages for a wrongful death or personal injury claim, it will tax punitive damages. Compensatory damages make up the bulk of wrongful death awards. They refer to money given to a plaintiff for economic and noneconomic losses. During a wrongful death claim or survival action, compensatory damages may refer to funeral and burial costs, medical bills, lost inheritance, lost wages and benefits, legal fees, and emotional pain and suffering.
Compensatory damages for wrongful death are nontaxable, and thus will not count as income on a federal tax return. A punitive damage award, on the other hand, is taxable. Punitive damages intend to punish the negligent party for his or her misconduct. Punitive awards are somewhat uncommon in wrongful death claims; however, a judge may award them against a defendant who is guilty of intent to cause harm, malicious actions or gross negligence.
If you receive punitive damages for a loved one’s wrongful death, this portion of your settlement will be taxable under the rules of the IRS. You may also have to pay taxes on some of your settlement if your family deducted a loved one’s medical expenses on a previous tax year. If your loved one was suffering from a physical illness or injury for a long time, for instance, and you listed his or her medical expenses as a tax deduction, you would then have to pay taxes on the amount your family receives in medical compensation. Otherwise, you would have avoided paying taxes on medical care altogether.
How to Claim a Wrongful Death Settlement on Your Taxes
The confusing nature of wrongful death settlement taxation is why it is important to work with a personal injury lawyer from the very beginning of your case. Your lawyer can structure your settlement in a way that saves you from over-taxation. When organizing your wrongful death settlement, your lawyer will ask the defendant’s insurance company to clearly label each portion of the award as either compensatory or punitive damages, rather than lumping everything together. That way, when it comes time to submit your tax forms, you can easily see which part of your settlement is subject to taxation.
Without a clearly organized settlement, you may end up paying more in taxes than you lawfully need to as a plaintiff. The IRS may also mistake a chunk of your compensatory damages for punitive damages and penalize you for failing to pay enough in taxes. Organizing your settlement with assistance from an attorney can help you keep your award types separate. If you do have to pay taxes on part of your wrongful death settlement, include it as Other Income on Line 21 of Form 1040. Work with a tax professional for further assistance with taxation of a wrongful death settlement.