April 15 is closer than we think, and you may be wondering how to handle your personal injury or wrongful death settlement on your federal and state tax returns. It is hard enough to deal with the emotional aftermath of a serious injury, much less the loss of a loved one -- now you have to think about the tax implications? It may not seem fair, but -- we won't go so far as to say that neither the IRS nor the Pennsylvania Department of Revenue cares about someone's personal situation, but taxes really aren't about being fair.
Nevertheless, the answer to the question is, "It depends."
According to the Internal Revenue Service's website, wrongful death claims typically involve compensatory damages awarded for injuries (physical and mental). Compensatory damages are meant to reimburse the plaintiff for any economic loss suffered as the result of the death of the loved one. Remember, though, that settlements -- and jury awards -- may also include noneconomic damages for pain and suffering, punitive damages if the defendant acted with malice or willful disregard of the safety of the plaintiff, or any combination of the three.
When asking the question about taxation, then, it is important to look at the kinds of damages.
- Compensatory damages are excludable from gross income -- not taxable.
- Noneconomic damages are excludable from gross income as long as emotional distress is attributable to the wrongful death -- not taxable.
- Punitive generally cannot be excluded from gross income, but courts may defer to the laws of the state in which the wrongful death claim was litigated in certain circumstances -- usually taxable, but check with an attorney or a tax professional.
That brings us to Pennsylvania tax laws, where things are a little simpler. In this state, a taxpayer may exclude compensatory, noneconomic and punitive damages from state compensation calculations.
Tax law can be tricky, especially in a wrongful death case. There are estate and inheritance taxes to consider, there are income taxes for the decedent and for family members who receive damage awards … it can be a lot to handle when your defenses are down. Consider consulting with your attorney if you have questions or need additional guidance.
Sources: Internal Revenue Service, Pennsylvania Department of Revenue