When a loved one passes away due to someone else’s negligence or misconduct, families often pursue a wrongful death claim to recover compensation for their loss. These settlements can provide financial relief during an incredibly challenging time, covering medical expenses, lost income, funeral costs, and emotional damages. However, many families wonder: Are wrongful death settlements taxable?
At Mory & Colliersmith, PLLC, we understand how confusing tax laws can be, especially when dealing with the aftermath of a tragedy. Here’s a breakdown of what you need to know about the tax implications of wrongful death settlements.
The General Rule: Wrongful Death Settlements Are Not Taxable
In most cases, compensation received from a wrongful death settlement is not considered taxable income by the Internal Revenue Service (IRS). According to IRS Publication 4345, amounts received as compensation for physical injuries or sickness are excluded from gross income. Since wrongful death settlements are often tied to the damages caused by the victim’s death, they generally fall under this category.
However, the specific tax treatment can depend on the type of damages awarded. Let’s explore this further.
Types of Damages in a Wrongful Death Settlement
A wrongful death settlement may include several types of compensation, and the taxability of each type can vary:
1. Compensation for Medical Expenses
• Tax Treatment: Not taxable.
• This portion of the settlement reimburses the family for medical bills incurred before the loved one’s passing. These payments are typically excluded from taxable income.
2. Compensation for Funeral and Burial Costs
• Tax Treatment: Not taxable.
• Payments meant to cover funeral and burial expenses are generally not subject to taxes, as they are considered part of the damages related to the wrongful death.
3. Lost Income of the Deceased
• Tax Treatment: Potentially taxable.
• If the settlement includes compensation for the income the deceased would have earned had they lived, this portion may be taxable. The reasoning is that had the deceased earned this income, it would have been subject to income tax.
4. Pain and Suffering
• Tax Treatment: Not taxable.
• Compensation for emotional distress, mental anguish, or loss of companionship is typically tax-free, as it is tied to the emotional and physical toll of the wrongful death.
5. Punitive Damages
• Tax Treatment: Taxable.
• Punitive damages are awarded to punish the at-fault party rather than compensate the victim’s family. These amounts are generally considered taxable income.
State Laws and Tax Implications
While federal tax laws apply to wrongful death settlements, state laws may have additional rules or exemptions. For example, some states specifically exempt all wrongful death settlements from taxation, regardless of the type of damages awarded. An experienced attorney at Mory & Colliersmith, PLLC can help you navigate Kentucky’s laws and ensure compliance with state and federal tax regulations.
Structured Settlements vs. Lump Sum Payments
The method by which you receive your settlement can also impact its tax treatment:
• Structured Settlements: These provide payments over time and may offer certain tax advantages, such as spreading taxable portions over several years.
• Lump Sum Payments: Receiving the entire settlement at once may make taxable portions more noticeable and could impact your tax bracket for the year.
Discussing these options with a financial advisor or attorney can help you determine the best course of action for your unique circumstances.
Avoiding Common Tax Pitfalls
Here are a few tips to minimize the tax burden associated with your wrongful death settlement:
1. Understand Your Settlement Breakdown: Ensure that the settlement agreement clearly specifies how the damages are allocated. This can make it easier to determine what is taxable and what is not.
2. Work with a Tax Professional: A certified public accountant (CPA) or tax attorney can help you accurately report your settlement and identify potential tax-saving strategies.
3. Hire an Experienced Attorney: At Mory & Colliersmith, PLLC, we work closely with families to negotiate settlements that minimize tax liability while maximizing compensation.
Real-Life Example
One of our clients in Kentucky received a wrongful death settlement that included damages for lost income, pain and suffering, and funeral costs. By clearly itemizing the settlement, we ensured that only the lost income portion was subject to taxes. This helped our client retain the majority of their compensation to support their family during a difficult time.
Get Expert Guidance Today
Losing a loved one is an unimaginable tragedy, and worrying about taxes on a wrongful death settlement should be the last thing on your mind. At Mory & Colliersmith, PLLC, we are here to guide you through every step of the process, from pursuing your claim to understanding the financial and tax implications of your settlement.
If you have questions about wrongful death settlements or need help with a claim, contact us for a free consultation at (502) 212-4333 or visit morycolliersmith.com. Let us handle the complexities so you can focus on what truly matters—healing and honoring your loved one’s memory.