There is no such thing as a Tax-Free Structured Settlement Annuity
While you may see the term “tax-free structured settlement annuity” on the Internet, there is no such thing. The structured settlement annuity does not drive the tax consequences to the Payee.
The type of damages the structured settlement payments represent is what drives the tax consequences
Damages are sum(s) of money claimed or awarded in compensation for a loss or an injury.
Let’s break it down further, together:
- These are the primary categories for which there is a tax exclusionIRC 104(a)(1) Workers Compensation
IRC 104(a)(2) Personal physical injury or physical sickness, wrongful deathIRC 139F Wrongful incarceration - A settlement is a negotiated compromise.
- A structured settlement cannot be established if constructive receipt has occurred.
- The parties to the settlement memorialize the terms of their compromise in a written Settlement Agreement and Release executed by the parties.
- A structured settlement annuity is an insurance product and is a contract, most commonly created as a “qualified funding asset” pursuant to the terms of a Settlement Agreement and Release and a Qualified Assignment Agreement to fund future periodic payment obligations set forth in the aforementioned settlement documents. In some cases, such as where the settlement is a death claim or involves the settlement of claims on behalf of a minor or incompetent, court approval of the settlement may also be required.
- The term “qualified funding asset” means any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State, or any obligation of the United States, if—
- such annuity contract or obligation is used by the assignee to fund periodic payments under any qualified assignment
- the periods of the payments under the annuity contract or obligation are reasonably related to the periodic payments under the qualified assignment, and the amount of any such payment under the contract or obligation does not exceed the periodic payment to which it relates
- such annuity contract or obligation is designated by the taxpayer (in such manner as the Secretary shall by regulations prescribe) as being taken into account under this section with respect to such qualified assignment, and
- such annuity contract or obligation is purchased by the taxpayer not more than 60 days before the date of the qualified assignment and not later than 60 days after the date of such assignment. See IRC 130(d)
When Are Payments from a Structured Settlement Annuity Not Tax-Free?
Payments from a structured settlement annuity are not tax-free when they represent damages that are not excluded under the Internal Revenue Code. A structured settlement annuity can be used to fund the periodic payments under a non-qualified assignment (also known as a non qualified structured settlement or tax-deferred structured settlement)
Note that at the time of publication structured settlement annuities may be used to fund tax exempt damages using a non-qualified assignment. These include:
- Wrongful incarceration under IRC 139F. where the structured settlement annuity is issued by Metropolitan Tower Life Insurance Company or Independent Life Insurance Company
- IStructure Uncapped Index Linked Structured Settlement Annuity issued by Independent Life Insurance Company
