Most people never think they will need to file a wrongful death lawsuit, which means most people have no idea how the settlement works when it comes to tax season. Do you have to report the settlement and pay taxes on this amount? This matter is more complicated than simply “yes” or “no.” It is very important to have a straight answer so you do not get in trouble with the IRS. The key to remember is whether or not the settlement is a form of compensation or not.
Compensation
For each type of damage you receive, you need to ask whether it is a form of compensation for something that is rightfully yours, or if it is a payment to make amends for wrongdoing. This can be a tricky distinction, so consider an example: Would compensation for funeral costs be taxed?
You had to pay for funeral costs because of the death. This is an amount that you would not have had to pay under normal circumstances. You are simply being compensated for an amount that would not normally be taxed, which means this type of damages should also not be taxed.
On the other hand, consider compensation for emotional distress. It does not correspond to financial loss, and is instead paid to make amends. This means that it technically counts as a form of income, which means it is taxed just like any other form of income. Likewise, punitive damages and other types of non-financial compensation are all taxable.
Lost Wages
Lost wages are a type of financial compensation corresponding to the paycheck the deceased was unable to earn. Since it is compensation for a financial loss, you may expect it to not be taxable. This is actually the one exception to the rule. Because the income would have normally been taxed, the fact that it was gained through a lawsuit settlement does not remove its need to be taxed.
How to File
It can be a little tricky to figure out the proper way to report the damages from the lawsuit. Follow this process:
- Determine if any portion of your settlement is taxable.
- If none of it is, you do not need to do anything special or report the settlement to the IRS.
- If even a small portion of the settlement is taxable, you must report the whole amount and claim any non taxable portions as deductibles.
It may be a good idea to speak with a tax professional or a wrongful death attorney, like a wrongful death attorney in Lakeland, FL, for help.
Thanks to David & Philpot, PL for their insight into what is and is not taxable in wrongful death settlements.
