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 recertifying 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.
Let Peachtree help
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 your payments is a regulated process and we have a lot of experience with these transactions. And while every structured settlement is unique, which means every payment sale will be different, they all have the same basic six steps:
- Call one of our representatives.
- Receive a free, no-obligation quote for the sale of your payments.
- Review and sign the purchase agreement.
- We process the agreement with your insurance company and local court.
- A judge reviews the transaction and, if approved.
- You get your cash!
Why should you choose Peachtree?
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. 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.
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.
