Taxation of Wrongful Death Settlement Proceeds
Written by: Steven J. Fromm, J.D., LL.M. (Taxation)
Taxpayers and litigation attorneys often question whether litigation awards or settlements are subject to income tax and federal estate tax. The following are some of the basic rules in this area.
Settlement for Wrongful Death Are Income Tax Free
Settlements for wrongful death are tax-free. Although IRS Publication 4345 does not go into a lot of detail, wrongful death claims fall into the category of compensation for physical injuries. Compensatory damages awarded for wrongful death are always income-tax exempt to the survivors.
Punitive Damages As Part of the Award Are Not Taxable
Although punitive damages are usually taxable, depending on the state law, they may be exempt from income if they are part of a wrongful death claim.
Wrongful Death Claims Are Part of Decedent's Estate and May Be Subject to Estate Tax
A wrongful death claim is considered property of the decedent's estate and would be includable for estate tax purposes.
However, due to the federal exemption for estate taxes, unless the estate had substantial other assets, this should not be an issue for the following reasons. For decedents dying in 2011, the federal estate tax exemption is $5 million and for 2010 there was no federal estate tax. Therefore, as long as the total value of the decedent's estate, including the settlement, was below these estate tax thresholds applicable for the year of death, there would be no federal estate tax to be paid.
For state inheritance taxes, the taxation of these wrongful death proceeds depends on the specific state involved. For example, Pennsylvania does not subject such awards to their inheritance tax.
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