Your knowledge about the term “structured settlements” may be limited to the glaring ads on late-night TV, but that doesn’t mean you don’t need to pay attention to them. Hundreds and thousands of civil cases across America, mainly related to personal injury and accident lawsuits, never make it to trial. Why? It is because both parties reach a settlement agreement earlier in the process of litigation.
The agreement requires the plaintiff to discontinue further legal action in exchange for receiving an amount of money from the defendant or the defendant’s insurance company. Compensation payments usually happen in a lump sum or regular payments over a given period, which is known as structural settlements.
When is a structured settlement awarded?
A structured settlement is particularly helpful when the plaintiff has suffered either permanent or severe injury classified as “catastrophic injury.” With this agreement, a defendant’s insurer typically assigns funding for an annuity policy for the plaintiff where they are made entitled to a steady stream of income over a particular term covering the settlement.
These annuity contracts range in various degrees of complexity to cover many different expected expenses. But before you accept any settlement agreement, always discuss all available options either with a personal injury attorney, a tax attorney, or certified public accountant (CPA) to fully explore consequences of a verdict.
What are the tax benefits of a structured settlement?
In simple terms, a structured settlement gives you an opportunity to settle a claim for accidents of physical injury in a series of payments over a certain period of time. This applies to workers compensation claims as well where an agreed amount distributed over a series of years in order to settle the deviance.
As far as taxes in relation are concerned, you can expect the following benefits:
- Tax-free income: The most significant advantage of a structured settlement is perhaps the fact that the IRS treats the entire ordeal as tax-free. According to section 104 (a) (2) of Internet Revenue Code, there shall be no tax obligation for the full amount in regards to a structured settlement that is related to personal injury.This rule applies in the case of section 104 (a) (1) worker’s compensation awards as well. Structured settlements also offer the flexibility to be paid to a named beneficiary, similar to the form of survivor’s benefits.
- Better returns: In the prevailing market scenario, very few investments offer a truly tax-free investment income stream. While there are some possibilities of tax-deferred investments, most of these have a high level of unpredictability or come with very low returns. However, structured settlements can be seen as an equivalent to an investment earning thanks to the tax-free nature of this idea.You stand a chance to make more per year regardless of market fluctuations without worrying about administration or management fees.
- Personalized payment policies: Sure, the income from structured settlements might be tax-free, but there is an additional benefit that people often overlook. Payments for structural settlements can be arranged in a way that can make quite a lot of difference for an individual’s tax, budgeting, and estate planning.Escalators and benefit raises can be included as a part of the settlements to address concerns about future income, inflation, as well as estate planning. Lifetime payments can also be a possibility that would help secure additional revenue after retirement.
- Guaranteed payments: In most states, annuity contracts enjoy the protection of state insurance laws that guarantee obligations of an insurer to be covered. Even though the federal legislation doesn’t permit an insurer to declare bankruptcy formally, most states also provide a safety net for insurance agencies that become insolvent.Policy claims and insurance companies will continue to be covered by the home state’s Guaranty Association, subject to state laws and limits.
The federal tax exclusion does not apply to payments due received for punitive damages. The federal tax law is also subject to change and various interpretations. Discussion regarding taxes in this article is intended to be general in nature and based on an understanding of how tax laws currently apply.
You should always consult your own tax advisor to determine how the tax law applies to your situation as state tax legislation and cases vary. In any case, you stand a chance to benefit from the structured settlement in more ways than one if its handled correctly.