When you’ve lost a loved one due to someone else’s negligence, receiving payment for your loss doesn’t make it better. The law does give you the right to sue the person who caused the death, and the Internal Revenue Service typically doesn’t take a portion in taxes if you successfully reach a settlement. Most wrongful death settlements or court-ordered judgments are tax-free. As is usually the case with tax law, however, there are a few exceptions.
A wrongful death lawsuit settlement is a monetary award granted to the survivors of a person who has died due to corporate or individual misconduct or negligence. The family members of the decedent may file a lawsuit that accuses another person or a company of being partially responsible for the death of their loved one. If the court agrees, the judge may award damages and financial payments to the surviving family.
Since these settlement amounts can be substantial, some fear that receiving their settlement will cause them to owe a high amount of tax to the Internal Revenue Service, but many wrongful death lawsuit settlements are not taxable by the IRS. This also means that small businesses that are forced to pay wrongful death lawsuit settlement awards cannot deduct them as a business expense.
According to the IRS, any lawsuit settlement proceeds that a court awards for physical illness or injury are non-taxable. This includes wrongful death settlements, since the damages are imposed due to a court’s finding that a third party is responsible for the physical illness or injury that resulted in death. To qualify for this exception, the settlement must be compensatory, meaning that it must be a form of compensation for the pain and suffering caused in the case.
The IRS draws a line between compensatory and punitive damages. Compensatory damages are just what they sound like – they’re intended to compensate you for your loss. It’s a little like saying that the cash award or settlement will return your life to what it used to be. The IRS doesn’t tax compensatory portions of personal injury settlements such as judgments awards or wrongful death suits because they are included under the tax umbrella for personal injury litigation. Compensatory damages are not considered a “gain”, they are intended to place the aggrieved party in the position they were in before the injury.
Since compensatory proceeds are nontaxable, they have no impact on a federal tax return. However, if there are any additional proceeds that are awarded such as punitive damages, payments for emotional distress, or awards for lost wages, those payments are considered income and are subject to income tax. Punitive damages are additional financial awards that a court may give to the family of a deceased or injured person in cases where the company or individual responsible for the death showed gross neglect or disregard.
Punitive damages are a different matter where the IRS is concerned. These usually come into play if the negligence that caused your loved one’s death was particularly outrageous or egregious – the death wasn’t the result of an understandable oversight or mistake, but of a deliberate or irresponsible action. Punitive damages act as punishment, and the IRS wants its share of these proceeds if your settlement or judgment includes them. Don’t be fooled if your settlement or judgment doesn’t actually include the word “punitive.” These damages are sometimes called “exemplary” damages. By any name, you must claim them as income.
A portion of your compensatory damages might be taxable if, in previous years, you took deductions from your income for medical bills related to the accident or events that resulted in your loved one’s death. In Louisiana, the law places no limitation on how wrongful death settlements are distributed between family members.
So if you’ve always claimed a standard deduction when filing your taxes, you’re in the clear – it’s only possible to claim medical deductions if you itemize. In you did claim medical expenses, you didn’t pay taxes on this portion of your income. If you recover money in a settlement or lawsuit, you must report on your return a portion of the award equal to the amount you deducted. The general rules on punitive damages can sometimes be reversed as well. Some states recognize only punitive damages in wrongful death suits, and the IRS defers to state law in these jurisdictions so you would not have to pay taxes on them. Complicated rules apply, so it is always recommended that you speak with a legal professional if you think you might qualify for this exemption.