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Details on the federal taxability of lawsuit settlements can be found in IRS Publication 4345. According to the IRS, wrongful death claims fall into the category of compensation for physical and mental injuries.
According to the IRS, any financial lawsuit settlement payments that a court awards for physical illness or injury are almost always income-tax exempt to the survivors. This includes wrongful death settlements, since the money is a result of a court decision that a third party is responsible for the physical illness or injury that resulted in death. In the IRS guide on lawsuits, awards and settlements, amounts determined to be compensatory for personal physical injuries or illness are excludable from gross income under IRC § 104(a)(2).
Non-taxable settlements related to physical injuries may include awards for compensatory damages, including lost wages received as a result of the physical injury, medical expenses not previously deducted, and pain and suffering.
Also excludable from taxable income are emotional damages awarded which are related to the physical injury or sickness. Acceptable expenses must be reasonable, and may include medical bills for psychological treatment or counseling, lost workdays, medications and antidepressants, and more.
In New York, compensation for personal injuries and pain and suffering is tax-free. This includes settlements received as part of a wrongful death action. As is usually the case with tax law, there are a few exceptions to the general tax-free rule for wrongful death settlements:
- Any portion of a settlement which was specifically designated as coverage of lost wages will be taxable.
- Awards for emotional distress or pain and suffering in a wrongful death settlement are usually taxable to the estate.
- If the personal injury settlement or wrongful death settlement proceeds were invested in taxable investments by an individual or the estate, any profit or gain will be taxable.
Punitive damages awarded are almost always taxable. 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 reckless conduct, maliciousness, gross neglect or disregard. Amounts determined to be punitive are not excludable under IRC § 104(a)(2).
A wrongful death claim is considered property of the decedent’s estate and would be includable for estate tax purposes. However, due to the NYS Estate tax exemption for estate taxes, unless the decedent had substantial other assets, this should not be a concern.
When a settlement is reached in a wrongful death case, the plaintiff’s lawyer must petition the Surrogates Court for a court order approving the terms of the settlement, and deciding how the settlement should be allocated. In certain cases, a lawyer experienced with wrongful death settlements can look at the specific facts of a case to make sure a settlement is properly structured to avoid or minimize any taxation that is not otherwise due, passing more money directly to loved ones.
