Ask the tax adviser
Taxes on an inherited court settlement
Dear Tax Talk,
My father died in 2000 as the result of ingestion
of a prescribed drug, which was later removed from the market. My
mother filed a lawsuit in 2002. She died later that same year. As
executor of her estate, I recently signed an out-of-court settlement.
The drug company states that the settlement is specifically for personal
injury. None of the settlement is for punitive damages. I know that
under IRS code section 104 that the settlement amount would not have
been taxable to my mother. As her heir, is this settlement money also
nontaxable to me or must it be run through her estate/probated will?
If that is the case, I will have to pay inheritance taxes as the total
amount of her estate would then exceed the $1 million maximum.
Is there any way that I can avoid paying the government
this tax. Do I, as the person who is receiving the settlement have
the right not to be taxed because the settlement was "on account
of personal physical injuries or physical sickness." Punitive
damages were not awarded. I have asked numerous CPAs and tax attorneys
and no one seems to be able to give me an answer. Please help!
You've done a great job of expressing a difficult situation.
Your problem falls within two different areas of the tax law: income
and estate tax.
From an income tax perspective, section 104 of the
law excludes the settlement from income as it was because of wrongful
death. The money would not have been taxable for income tax to your
mother and similarly it is not taxable to you as her heir.
From an estate tax perspective, the settlement is
an asset of her estate, as was the claim. In 2002, estates valued
at less than $1,000,000 were not subject to estate tax and were
not required to file an estate tax return. Unlike income tax, estate
tax applies to the value of assets of a decedent, not the nature
of the assets. In estate tax there are rarely any exclusions of
assets as there might be for income tax purposes. For example, the
face amount of life insurance is exempt from income tax, but is
an asset subject to tax for estate tax.
Since you did not file an original return, you'll
need to file a late return reporting all the assets of your mother
and pay the estate tax due accordingly. Since the return is late
(assuming she died more than nine months ago) you will be subject
to substantial penalties for late filing (5 percent of the tax per
month to a maximum 25 percent).
I recommend that you find a qualified CPA in
your area to represent you in this matter, prepare an accurate return
and negotiate the waiver of the penalties.
-- Posted: Aug. 14, 2003