Structured settlements are a common way to resolve personal injury lawsuits and other legal claims. But their tax treatment and status as “income” can be confusing. This article will provide some context regarding how structured settlements are classified financially and for tax purposes. 

What qualifies as a structured settlement? 

Structured settlement payments are usually funded through an annuity purchased by the defendant or insurer. The terms of the settlement, including payment amounts and schedule, are customized based on the plaintiff’s needs and the specifics of the case. 

Structured settlements are common in cases involving: 

• • Personal injury claims 

• • Workers’ compensation 

• • Medical malpractice 

• • Wrongful death suits 

Legality and tax status 

The key question is: Are these periodic payments considered income for tax and other purposes? The short answer is: generally no, structured settlement payments are not considered taxable income. However, there are some important nuances and exceptions to understand. 

The tax treatment of structured settlements is primarily governed by the Periodic Payment Settlement Tax Act of 1982. This law amended the Internal Revenue Code to provide favorable tax treatment for certain types of structured settlements. 

Under Internal Revenue Code Section 104(a)(2), compensation for personal physical injuries or physical sickness is excluded from gross income. This applies whether the compensation is received as a lump sum or as periodic payments under a structured settlement. 

Qualified vs. non-qualified structured settlements 

It’s crucial to distinguish between “qualified” and “non-qualified” structured settlements. 

• • Qualified structured settlements: Arise from personal physical injury, physical sickness, or wrongful death claims. These payments are fully tax-exempt (federal, state, and local taxes) and cannot be modified once established. 

• • Non-qualified structured settlements: Arise from non-physical injury claims (e.g., employment disputes, property damage). Payments are partially taxable – the principal portion is tax-free, but any interest or earnings are taxed as ordinary income. Non-qualified settlements may offer more flexibility in terms of payment schedules and potential modifications. 

Exceptions and special cases 

While the general rule is that qualified structured settlement payments are not taxable income, there are some exceptions: 

• • Punitive damages: Even in personal injury cases, any portion of a settlement explicitly allocated to punitive damages is taxable. 

• • Interest: If a structured settlement includes interest payments, those interest amounts may be taxable. 

• • Non-physical injuries: Settlements for emotional distress or other non-physical injuries are generally taxable unless they stem from a physical injury. 

• • Sale of structured settlement rights: If the recipient sells their right to future payments (often called “factoring”), the proceeds may be taxable. 

Structured settlements and means-tested benefits 

While structured settlements are generally not considered taxable income, their status regarding means-tested government benefits is more complex: 

• • Social Security Disability Insurance (SSDI): Structured settlement payments do not affect SSDI benefits, as SSDI is not means-tested. 

• • Supplemental Security Income (SSI): Structured settlement payments may be counted as income for SSI purposes, potentially reducing or eliminating eligibility. 

• • Medicaid: Treatment varies by state, but structured settlement payments may be counted as income or resources for Medicaid eligibility. 

To address these issues, some structured settlements incorporate a Special Needs Trust to preserve eligibility for means-tested benefits. 

Reporting structured settlement payments 

Even though qualified structured settlement payments are not taxable, recipients may still need to report them in certain situations: 

• • Non-qualified settlements: Interest or earnings portions should be reported as income. 

• • State requirements: Some states may require reporting of structured settlement payments for informational purposes. 

• • Means-tested benefits: Payments may need to be reported when applying for or rectifying eligibility for certain programs. 

The takeaway 

In most cases, payments from a qualified structured settlement arising from personal physical injury or sickness are not considered taxable income. This favorable tax treatment is one of the key benefits of structured settlements, allowing recipients to receive their compensation over time without incurring additional tax liability. 

However, the specific circumstances of each case can affect the tax and financial implications of a structured settlement. Non-qualified settlements, punitive damages, and the sale of settlement rights can all lead to different outcomes. Additionally, while structured settlements may not impact income tax, they can affect eligibility for certain means-tested government benefits.