Posted on: 18 March 2016
Taxes aren't the most enjoyable subject at the best of times, and they certainly aren't high on your priority list after you've suffered an unexpected death in the family. But if you're pursuing a wrongful death claim and expecting to receive a settlement or judgement, it's important to consider whether or not the money will have an impact on your tax situation. You don't want to be caught unawares if you're going to owe the IRS money. Take a look at a few things that you need to know about how your wrongful death claim will affect your taxes.
The Good News
You can win or settle a wrongful death suit when your loved one's death was caused by a physical injury or illness caused by a person or an entity, like a hospital or a business. The IRS excludes lawsuit winnings that are awarded as the result of a physical illness or injury – called compensatory damages – from taxation.
That means that as a rule, your settlement or judgement from your wrongful death claim should be free from taxation. Even though you weren't the one that suffered a physical illness or injury, your loved one did, and the proceeds of the lawsuit are related to that illness or injury. Therefore, you won't owe taxes on that money, and you don't have to worry about it affecting your tax returns in most circumstances. However, there is one exception.
Punitive damages are a type of financial punishment awarded as a way of punishing the defendant for their actions. They aren't determined by the actual financial loss that you suffered as a result of the death – instead, juries decide to award punitive damages when they conclude that a large payment may prevent the defendant from repeating the actions that led to the lawsuit in the first place. Usually, punitive damages are used when the defendant was not merely negligent, but was acting with reckless disregard or out of malice. For example, you may sue a hospital for a medical mistake by a negligent doctor and be awarded with only compensatory damages. But if the hospital was knowingly allowing the doctor to perform medicine without a valid license, they would most likely be subject to punitive damages.
Unlike compensatory damages, punitive damages are taxable. This is because they are not awarded to compensate the victim in any way – they simply punish the defendant. Therefore, they're considered a windfall and taxed accordingly. If you're awarded punitive damages, you need to report them when you file your taxes for the year – failure to do so can lead to fines and penalties from the IRS. Because taxable punitive damages are usually awarded with nontaxable compensatory damages, you may find that your tax situation is confusing.
If you've filed a wrongful death claim seeking both compensatory and punitive damages, it's a smart idea to speak to a tax professional, like a CPA, to find out exactly how the award will affect your taxes. Tax rates vary based on your location and your overall financial situation, so you'll need an expert who can advise you on your personal circumstances.
Your personal injury lawyer is most likely not a tax expert, so don't rely on them for tax advice. However, if your attorney has previous experience with winning large judgements for clients, they may be familiar with the tax pitfalls that one can fall into after a punitive damage award, and may even be able to recommend a good tax professional in your area – don't be afraid to ask for a referral. If you haven't filed your claim yet, it may be a good idea to discuss the possible tax implications of a punitive award ahead of time – depending on your situation, it's possible that seeking punitive damages is not a smart financial move, and you'll want to discuss that with your lawyer before the lawsuit is filed.
It's in your best interest to make sure that all of your bases are covered when it comes to your tax responsibility after a lawsuit. Being aware of when you do and don't owe taxes on a wrongful death judgement and knowing when to seek financial help can protect you from overpaying or underpaying. If you have not yet retained an attorney, check out a firm like Bangel, Bangel, & Bangel.Share