Aug 21, 2024
•
5 min
Are Structured Settlements Considered Income?
This article will provide some context regarding how structured settlements are classified financially and for tax purposes....
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This information is provided for educational and informational purposes only. Such information or materials do not constitute and are not intended to provide legal, accounting, or tax advice and should not be relied on in that respect. We suggest that You consult an attorney, accountant, and/or financial advisor to answer any financial or legal questions.
You’ve heard the term before, and chances are if you’re reading this article, you’re probably in the process of receiving one. A structured settlement is an arrangement where a party agrees to pay out a settlement over a period of time through a stream of payments, rather than paying the full amount in one lump sum. These periodic payments are funded by purchasing an annuity from a life insurance company.
Structured settlements are commonly used to resolve personal injury, workers’ compensation, and other tort claims. They provide guaranteed tax-free payments to the injured party for a set number of years or for the recipient’s lifetime.
In general, the periodic payments you receive from a structured settlement for personal injury or sickness are not taxable under Section 104(a)(2) of the Internal Revenue Code. This means you do not have to pay federal income tax on the money you receive from your structured settlement payments related to compensatory damages for physical injury or physical sickness.
It’s important to note that this tax exemption only applies to damages for physical injuries or physical sickness. Payments received for mental/emotional distress are generally taxable, unless the emotional distress stems from the physical injuries.
If a portion of your settlement is for something other than physical injury or sickness, like punitive damages or interest income, that portion may be taxable. Your settlement documentation should specify the breakdown, so be sure to read the fine print.
Sometimes recipients opt to take a discounted lump sum payment instead of periodic payments from the structured settlement. In this case, the lump sum payment retains the same tax characteristics as the structured payments would have had.
So, if you take a lump sum for a settlement that was entirely for compensatory damages from physical injuries, the full amount would be tax-free under Section 104(a)(2). But if part was for punitive damages or other taxable items, that portion would be taxable.
While structured settlement payments for physical injuries are exempt from federal income tax, they are still considered part of your taxable estate for federal estate tax purposes if remaining guaranteed payments exist at your death. On the bright side, that won’t be your problem.
However, the periodic tax-free payments from the structured settlement’s annuity can be stretched over two generations without incurring gift taxes by utilizing the tax law’s personal annual gift tax exclusions. In other words, your family can still benefit from your payments, tax-free, for up to two generations.
Although federal tax law exempts compensation for physical injury or sickness, some states do tax certain types of legal settlements and damage award payments. You’ll need to check the laws in your state regarding the taxation of structured settlements and other legal damages.
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At Peachtree Financial Solutions, we’ve helped thousands of people get their money sooner by purchasing their future payments for a lump sum of cash. Selling some or all of your payments allows you to take control of your finances and create opportunities for yourself.*
It’s all part of something we call the Peachtree Promise: our experienced, dedicated representatives listen to your goals and clearly explain your available options. We meet you where you are without judgement and work hard to help you meet your financial goals.
When you call Peachtree, your representative will ask you for the following:
To provide you with your quote, your rep might also ask you how you received your settlement. We recognize that this may be a sensitive topic, and you won’t have to give us all the specifics. You can trust us to treat your case with compassion and discretion.
Once your rep has the information they need, they can build you a quote—usually within a day. Getting your quote is completely free, and you’re under no obligation to sell to us if you aren’t completely satisfied with what you hear.
Overall, while the taxation of structured settlements can seem complex, the core rule is that compensation received through periodic payments or a lump sum for physical injury or physical sickness is not taxable as income at the federal level – and state laws vary. However, payments for other damages like punitive damages or income earned may be taxable.
As with any tax matter, consulting a qualified tax professional is advisable given the specifics of your situation.
* Sales of Structured Settlement and Lottery Payments are subject to Court Approval and other conditions which can take 60-90 days to complete. Annuity payment sales are also subject to certain conditions. All transactions are at our sole discretion.
Peachtree Financial Solutions is here to help people from all walks of life reach their financial goals. From moving into a bigger home, to getting a more reliable car, to paying tuition, we’ve helped tens of thousands of people.
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