I. Settlements involving personal physical injury, physical sickness, workers compensation or wrongful death

A properly designed structured settlement generates payments that are " income  tax-free" under Internal Revenue Code §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 §104(a)(1).

Note: Structured settlements may be used to pay damages for wrongful incarceration, for which an exclusion applies at §139F.

IMPORTANT PRO TIP!

If a General Release has already been signed and delivered to the legal representative of the Defendant, the tax-free benefits that a tax qualified structured settlement offers, may no longer be possible.

What is the structured settlement tax break worth? 

Check out our taxable equivalent yield chart. On the same page you will also be able to view the net taxable yield if the alternative investment used for comparison is taxable.

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 is $12, 920,000* for 2023 ($25,840,000 for married couples), so unless (1) 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 (2) 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 is in excess of the exempt amount, the Federal may be less of an issue. State estate and inheritance taxes in some states, however, may have lower exemptions and estate and inheritance taxes might be applicable.

States Which Impose Estate Tax and Their Estate Tax Exemptions for 2024

Connecticut $12,920,000 since January 1, 2023

New York $6,580,000. Phased out for New York taxable estates valued between 100% and 105% of the exemption amount.

Hawaii $5,490,000

Illinois $4,000,000

Oregon $1,000,000

Maine $6,010,000

Maryland $5,000,000

Massachusetts $1,000,000

MInnesota $3,000,000 ($5,000,000 for farmers and small business owners)

Rhode Island $1,733,264

Vermont $5,000,000

Washington $2,193,000

District of Columbia $4,254,800 

The use of a full or partial "structured settlement  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. The downside is that the commutation percentage must be decided at time of settlement and may be more or less than needed. 

Berkshire Hathaway offers a "shortfall-based" commutation provision that allows for a partial commutation of future payments sufficient to fund payment of estate tax and/or amounts owed to Medicaid that cannot be satisfied by the assets in the decedent's Special Needs Trust. There is special language that must be included in the Settlement Agreement and the Qualified Assignment documents. Another option is a Hardship Exchange at comparably favorable rates to its annuitants which uses the procedure set forth in IRC §5891, permitting a more precise liquidity event.  A number of other carriers have

*Note that the Federal exemption increase is only temporary and is set to expire in 2026. If not renewed the exemption reverts to $5,000,000

II. Settlements involving taxable damages or structured attorney fees or attorney fee deferrals

"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, psychological claims unrelated to personal injury, post judgment interest and more), or where a portion of the damages may be taxable, may also benefit from a tax-deferred solution utilizing non-qualified assignments and other solutions.  If constructive receipt has already occurred, then a non-qualified assignment may not be possible.

III  Construction Defect Cases

Construction defect cases are more nuanced and portions of damages paid might be considered a return of basis, such as the original investment as well as capitalized costs such as attorney fees.  While they may be untaxed, they are not excludible under the same code section as personal physical injury or physical sickness.

Last updated April 30, 2023

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