Hi and welcome to Just Answer!
According to the IRS - to determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces.
Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. However, interest income received as a result of life insurance proceeds may be taxable.
Also - you do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).
So far the settlement from an insurance company replaces non taxable items - and therefore should not be included into your income.
Only if part of that settlement includes interest income received as a result of life insurance proceeds or any other taxable items - that part might be taxable to you and your siblings.
Please see fro reference IRS publication 525 - http://www.irs.gov/pub/irs-pdf/p525.pdf
for Court awards and damages - see page 31
for life insurance proceeds - see page 21
for compensatory damages for personal physical injury - see page 19.
Please provide that information to your attorney for consideration.
Let me know if you need any help.
Be sure to ask for clarification if needed.
I should have mentioned that the settlement as a result of our father's death in an assisted living facility. His spouse was not living at the time of his death so the survivor benefits are to his 3 children.
The allocation of the settlement was determined by a judge and attorney's fees were paid.
I am sorry that your father was not treated properly.
However as long as the settlement replaces non taxable items - that amount is not included into taxable income for neither the estate nor for beneficiaries - regardless how beneficiaries are related to the decedent.
Attorney's fees related to non taxable income are neither taxable nor deductible for you - so there is nothing you need to report on your tax return.
I might suggest - to avoid possible confusions - contact the payer and verify that they would not report that income to the IRS.
Your attorney is correct - for estate tax purposes the amount of settlement is included into the estate. Both the wrongful death compensation and survivor benefits are included into the estate.
For federal estate tax purposes - ther e is no estate taxes for those passed away in 2010. If you father passed away in 2011 - estate tax return is due only if his total estate is above $5,000,000.
In Pennsylvania Inheritance Tax return - the lineal tax rate is applicable to all Class A heirs. For dates of death on or after July 1, 2000, the lineal tax rate is 4.5%. Class A beneficiaries are defined as: Grandfather, grandmother, father, mother, children, un-remarried wife and husband or widower of a child, and lineal descendants.
However - for estates of decedents with a date of death after December 12, 1982, all life insurance policies on the life of the decedent, payable to the estate or to a named beneficiary, are exempt from Inheritance Tax.
See for reference page 14 - http://www.portal.state.pa.us/portal/server.pt/document/628145/rev-1501_pdf