Tax Free vs. Tax Deferred

Tax Benefits of Structured Settlements
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.
tax benefits of structured settlements
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). 

What is the structured settlement tax break worth?  Check out our taxable equivalent yield chart.
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 $5,490,000 for 2017, 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 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.

Sample State Estate Tax Exemptions
CT  $2,000,000
NY  $5,250,000 (death after April 1, 2017). Will increase to equal Federal Estate tax exemption  January 1, 2019.
The current trend is the effective reduction or elimination of state estate taxes through increasing of exemptions.  DE and NJ will repeal their estate taxes effective December 31, 2017. DC will increase its exemption to the federal exemption for those who pass after December 31, 2017. MN, RI and WA are gradually increasing their exemptions

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. The downside is that the commutation percentage must be decided at time of settlement and may be more or less than needed. At least one company offers 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.
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, psychological claims unrelated to personal ionjury, 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.
Share by: