Who Qualifies for a Structured Settlement?
Structured settlements come in two varieties: tax-free and tax-deferred.
Which kind you qualify for depends on the kind of injury you have suffered.
- If you suffered a physical personal injury, your future payments are fully exempt from income tax at both the federal and state level. Under Internal Revenue Code Section 104, payments received on account of personal physical injury or physical sickness are entirely excluded from gross income. This is true whether the money is received as a lump sum or as periodic payments.
- If you suffered a non-physical personal injury, your settlement is fully taxable in the year you receive it. This can create major tax problems if you elect to receive your settlement in a single lump sum. Choosing to receive all your settlement in the same tax year can force you into an artificially high tax bracket, cost you significantly more in taxes than is otherwise necessary, and sharply reduce your net recovery.
A better strategy for many is to spread your settlement payments out over a number of years to hopefully bring them in at a lower tax rate. Deferring taxes in this manner cannot only reduce the immediate tax owed in the year of settlement, but also increase your ultimate return by permitting the deferred amounts to grow tax-free until received.
- If you are a personal injury attorney, you face the same potential "tax bracket leap" as described above for non-physical injury claimants. Allocating a portion of your fee to be paid in future years on a tax-deferred basis potentially reduces taxable income in the year of settlement, increases returns on allocated funds through tax-free growth, can help smooth out the famously uneven revenue flow of your business, and permits more flexible retirement planning.