Taxation of Structured Settlements

Structured settlements are tax-free financial vehicles meant to compensate for personal injuries and losses. However, there are a few exceptions to the rule that could incur tax liabilities.

Structured settlements are annuities awarded as recompense in a civil lawsuit. These financial vehicles are meant to provide a long-term income stream to maintain a claimant’s financial needs. In some cases, structured settlements are provided as a one-time lump sum payment.

Unlike some financial investments, structured settlements usually have no tax implications. According to the Periodic Payment Settlement Act, structured settlement payments are considered nonqualified, prohibiting the IRS from taxing any income. This means income from personal injury settlements are exempt from local, federal and state taxes. Any accrued interest from the settlement contract is also tax-free.

Workers’ compensation settlements, along with payments from wrongful death lawsuits, are included in this tax-free benefit.

However, there are some situations that could bring into question some tax liabilities.

Punitive Damages

Punitive damages, also referred to as exemplary damages, are damages a defendant may be ordered to pay for reckless or negligent behavior. Though they can be awarded in personal injury cases, punitive damages are not paid to compensate for an actual injury. Instead, this monetary reward is seen as a punishment to the defendant for causing you harm as the claimant.

Since this award is not meant to make up for your health or meant to contribute toward medical expenses, any income received from punitive damages is considered taxable.

Lottery Structured Settlements

Lottery winnings do not have the same benefits as personal injury structured settlements. Lottery winnings are taxed in two different ways depending on how you receive them.

If you receive a lump sum payment, all of the income received is taxable. It will be subject to federal and state taxes at one time. Then you can spend or invest the money as you see fit.

If you receive periodic payments from a lottery structured settlement, each payment is subject to current federal and state taxes. The advantage of receiving a structured settlement over a lump sum payment is that taxes are paid gradually.

Workers’ Compensation Exceptions

Workers’ compensation is paid if you get injured or sick as a result of your work. Workplace damages are not considered taxable income, specifically if awarded amounts contribute toward medical bills.

However, if you receive a settlement to supplement lost income from a work-related injury, you will have to pay taxes on payments. In addition, if you receive a workplace settlement from a discrimination or slander case, your payments will be viewed as taxable income.

A portion of your workers’ compensation benefits may also be taxable if combined with Social Security income or other supplemental Social Security benefits.

Selling Your Structured Settlement

Just as personal injury settlements are not seen as taxable income, so are the future sales of these payments as long as the contract terms do not change. However, all structured settlements that fall outside of personal injury can be taxed, including the sale.

You can choose to sell all or a portion of your payments, but at a discounted rate in exchange for immediate access to your cash. Unlike more common structured settlements, not all lottery winnings can be sold. If you choose to sell your lottery structured settlement, you must first ensure that it can be sold. Some lottery settlements require court approval in order to be sold to ensure the transaction is at the winner’s best interest.

Let CBC Help

Our team of experienced, caring professionals will make the process of selling some or all of your structured settlement or annuity payments easy.