Structured settlements are a form of compensation for damages awarded to an individual, usually as a result of a personal injury or wrongful death lawsuit. These settlements are typically paid out in periodic payments over a period of time, and the money received is not considered taxable income. However, there are certain circumstances in which the money received from a structured settlement may be subject to taxation. In general, structured settlements for compensatory damages are exempt from tax, so are profits from the sale of future payments.
This means that if you receive a settlement for personal injury or wrongful death, the money you receive is not considered taxable income. However, if the settlement is for something other than personal injury or wrongful death, such as a lottery winnings or workers' compensation, then the money may be subject to taxation. One way to avoid taxation on structured settlement payments is to establish a structured settlement annuity. This is an annuity that is funded by the defendant at the time of the settlement agreement and pays out periodic payments to the recipient.
All interest that grows within the structured annuity will also be exempt from taxes. Payments received from a structured settlement annuity need not be reported on any tax return form (1040) or any tax document. Both the principal amount and interest on the annuity are completely tax-exempt. If you decide to sell a structured insurance agreement, which is usually done to receive the remaining lump sum, that money is also not taxable until the original contract is modified.
However, if you receive periodic payments from a structured lottery settlement, each payment is subject to current federal and state taxes. In 1996, a change in the tax code established that injuries must be of a physical nature for settlements to receive tax-exempt status, according to the U. S. Bar Association.
Although lawmakers prefer people to keep their structured agreements, there are no negative tax consequences when selling settlement payments. In summary, structured settlements are among the least taxed forms of money that can reach someone. Depending on the reason for the settlement, there may be no tax, and they are transferable and inheritable. However, it's best to confirm the status of your contract before attempting to sell your payments in order to avoid any potential tax liabilities.