Are Wrongful Death Settlements Taxable?
After receiving a wrongful death settlement for the loss of a loved one, it is essential to know whether you will need to pay taxes on the money you receive. According to IRS Rule 1.104-1, compensation received for personal injuries and death is not taxable.
However, there are certain exceptions that could result in part of the settlement being taxable. Therefore, it is your responsibility to find out if wrongful death settlements are taxable.
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Table of Contents
- ARE WRONGFUL DEATH SETTLEMENTS TAXABLE
- WHAT COULD BE TAXED IN A WRONGFUL DEATH SETTLEMENT
- ARE THERE ANY EXCEPTIONS TO THE TAXATION OF WRONGFUL DEATH SETTLEMENTS
- CAN THE IRS TAKE MY WRONGFUL DEATH SETTLEMENT IF I OWE THEM MONEY
- HOW ARE WRONGFUL DEATH SETTLEMENTS DETERMINED
- IS THERE A WAY TO MAXIMIZE OR AVOID PAYING TAXES ON A WRONGFUL DEATH LAWSUIT SETTLEMENT
- HOW ARE WRONGFUL DEATH SETTLEMENTS PAID OUT
- HOW IS THE MONEY DISTRIBUTED FROM A WRONGFUL DEATH SETTLEMENT
- HOW CAN A WRONGFUL DEATH ATTORNEY HELP
What could be taxed in a wrongful death settlement?
Compensation from a wrongful death settlement will often fall into compensatory damages, including economic and noneconomic damages, and exemplary damages, like punitive damages. They are further broken down into physical, emotional, and punitive damages, and lost wages.
In most settlement cases, physical damages are non-taxable because they are not considered income. The money received for physical damages is usually used to pay medical expenses, funeral expenses, and other expenses related to the death of the loved one.
However, suppose you itemized your tax return and took deductions for any deductible expenses. In that case, you have to report the money received as income minus any allowed deductions you took in previous years or the current tax year.
Emotional damages generally are non-taxable when they are directly related to physical injuries. Therefore, since the loss of your loved one is an emotional experience that can often require counseling and other medical care, this part of the settlement would not be taxed.
However, they can be taxable income when they do not arise from physical injuries or if you took itemized deductions for any medical costs incurred due to your emotional anguish and pain and suffering. The amount taxed can be reduced by deducting any related medical expenses.
Punitive damages are awarded in wrongful death cases where the defendant’s actions are deemed to be grossly negligent. For example, the defendant knowingly chose to drive drunk and killed your loved one.
As such, part of your settlement or verdict could include punitive damages as a means to punish the defendant for their negligent behavior and deter others from doing the same. Since punitive damages are not directly related to physical or emotional damages, any amount received is considered taxable income.
Therefore, you must report punitive damages as taxable income to the IRS and pay taxes on that amount. However, IRC § 104(c) allows certain exclusions for punitive damages in wrongful death claims for compensation received after 1996 and in certain situations.
Any compensation received as part of your wrongful death settlement for lost wages—including past, present, and future wages—is considered taxable income. This is because, had your loved one survived and returned to work, they would have paid taxes on their wages.
Are there any exceptions to the taxation of wrongful death settlements?
As previously mentioned, certain exceptions exist where some or part of the taxable compensation received in a wrongful death case could be reduced or exempted. Since the IRS rules can be complex, having your wrongful death lawyer refer you to an accountant with experience filing tax returns involving wrongful death compensation is best.
Can the IRS take my wrongful death settlement if I owe them money?
Yes, the IRS can take part of your wrongful death settlement to satisfy back taxes you or your loved one owed. In cases where the IRS already has a tax lien on your house or other personal property or a court order to take money to satisfy the debt out of your bank account, they could require your attorney to deduct the amount owed from the proceeds you receive.
How are wrongful death settlements determined?
The amount offered as a settlement in a wrongful death lawsuit is determined by the impact the death will have on the deceased’s family. Compensation amounts first account for all economic damages and then noneconomic damages, such as:
- Medical Expenses
- Lost Wages
- Lost Benefits (Health Insurance, Life Insurance, etc.)
- Funeral Costs
- Property Damages
- Extent of Pain and Suffering the Deceased Experienced
- Pain and Suffering of the Family
- Mental Anguish of the Family
- Loss of Companionship/Consortium
Next, the extent of negligence is evaluated to determine whether there could be punitive damages. If there are grounds for punitive damages, then the wrongful death claim settlement may include those. However, in most cases, punitive damages usually are only awarded by a judge after the jury finds in favor of the plaintiff.
Is there a way to minimize or avoid paying taxes on a wrongful death lawsuit settlement?
You can do a few things to minimize or avoid paying taxes on a wrongful death lawsuit settlement. For starters, you will want to have the compensation you receive itemized on your settlement agreement between non-taxable and taxable income, should you receive taxable compensation.
Next, you will want to have records of all medical expenses, funeral expenses, and other deductible expenses you can take to reduce the amount of taxable settlement income. If you are unsure what qualifies, talk to a qualified accountant for assistance.
Another thing you can do that helps is to ensure your settlement money is kept separate from your other income, savings, and retirement money. You will want to open separate accounts and never mix your settlement money with your other money.
If you mix your money, you could face paying taxes on some or all of it, and it becomes more difficult to show what is and is not taxable income.
Lastly, you could consider a structured settlement. This type of settlement will ensure you receive a specific amount of money each year.
As a result, you only have to pay taxes on the amount received each year, deemed taxable compensation by the IRS. In addition, you do not have to worry about being bumped up several income tax brackets when you take a large, upfront settlement.
How are wrongful death settlements paid out?
Wrongful death settlements can either be paid out in one lump sum or as a structured settlement. Structured settlements are only possible when your wrongful death attorney is able to settle out of court. Should your case go to trial and the verdict rule in your favor, your settlement will be a lump sum payment.
How is the money distributed from a wrongful death settlement?
Once you receive your settlement, the money will be distributed as follows:
- Any medical and funeral expenses are paid on your behalf by your attorney.
- Your attorney collects their contingency legal fee you agreed to when you retained their services.
- Any other case costs are collected, such as paying for expert witnesses, medical records, etc.
- The remaining proceeds are divided according to Colorado interstate and succession distribution laws.
For example, if the deceased was married and had children with their spouse, the spouse usually receives all the proceeds. However, if the deceased had children from a previous marriage, the current spouse would receive half of the proceeds, while the children would split the other half.
How can a wrongful death attorney help?
Far too often, when a wrongful death occurs, insurance companies are quick to make a settlement offer. Unfortunately, the grieving family does not take the time to consider the amount of compensation they are legally entitled to receive. As a result, they do not get the full amount of compensation they deserve.
Speaking to a wrongful death attorney from Bachus & Schanker is free. Our attorneys want to ensure you receive the compensation you deserve. While no money will make up for your loss, we want to help you protect your future and not worry about not being financially secure.
IRC § 104(c). (2022).
CRS 15-11. (2020).