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George Saenz, the Bankrate.com Tax Talk columnistTaxes on a wrongful death settlement

Dear Tax Talk,
Earlier this year my mother, my sister and I received settlements for a wrongful death lawsuit involving the death of my father. The sums are large enough (the total being well into the six figures) to potentially cause us all problems with the IRS.

My question is, are these payments taxable income under federal tax law? All of the settlement papers indicate that no portion of the settlements represent punitive damages. They are all stated as compensatory damages, which as far as I know are treated somewhat like life insurance payments. Is this true?
-- Jon

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Dear Jon,
Don't worry, and rest easy. 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. Although punitive damages are usually taxable, depending on the state law, they may be exempt from income in a wrongful death claim.

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 your father had substantial other assets, this should not be an issue. 

For decedents dying in 2002 and 2003 the value of exempt assets was $1 million, for 2004 and 2005 the exemption was $1.5 million and in 2006 through 2008 the exemption is $2 million. As long as the total value of your father's assets, including the settlement, is below the threshold applicable to his year of death, the estate tax would not be an issue. 

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: Dec. 29, 2006
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