Tax Free vs. Tax Deferred
Structured settlements have tax advantages for recipients. Whether payments from a structured settlement are income tax free or tax deferred depends on the types of damages that the structured settlement payments represent.
I. Settlements involving personal physical injury, physical sickness or workers compensation
A properly designed structured settlement generates payments that are "income tax-free" under Internal Revenue Code Section 104(a)(2), which states, "Gross income does not include...the amount of any damages received (whether by suit or agreement and as lump sums or as periodic payments) on account of personal physical injuries or physical sickness." All income derived from this type of damages is tax-free, regardless of any other sources of income available to you. Amounts received under workers' compensation claims filed after August 5, 1997 also qualify for the exclusion pursuant to IRC Sec. 104(a)(1).
Calculate the taxable equivalent yield of a structured settlement
Important Note: While structured settlement payments are income tax free, in the event of death of the structured settlement payee, the present value of any due, but not received, certain or guaranteed lump sum future structured settlement payments would be included in the estate of the decedent. Thus they may be part of the estate or inheritance tax calculation. Plan accordingly. Estate or inheritance taxes, a tax on your right to transfer property at your death, may apply on both a Federal and statewide level. The Federal exemption was $5,450,000 for 2016, so unless you have a very large settlement in which the present value of the remaining settlement payments at the time of death is in excess of the exempt amount, or the present value of the structured settlement at time of death plus other asset in the name of the decedent at the time of death, the Federal will be less of an issue than it had been before the American Taxpayer Relief Act of 2010. State inheritance taxes however, have much lower exemptions and inheritance taxes might be applicable. The use of a full or partial "death commutation rider" may be helpful on the larger cases to which estate and inheritance taxes may apply and liquidity is likely to be an issue.
II. Settlements involving taxable damages or structured attorney fees.
"Tax-Deferred" means that taxes on an investment are merely delayed to a later date, when through surrender or withdrawal, income is received and taxes become due. In certain situations, the annuitant may be in a lower tax bracket, and may benefit from the interest earned on the "Taxation of structure settlement payments depends on the type of damages", but income earnings will never be "tax-free."
Attorneys who properly structure their fees may benefit from tax deferral, For more information, please review the section on structuring attorney fees or call us!
Plaintiffs in cases involving taxable damages (punitive damages, employment litigation, environmental cleanups and monitoring, contract disputes, construction defects, post judgment interest and more), or where a portion of the damages may be taxable, may also benefit from a tax-deferred solution utilizing a non-qualified assignment.