Structured settlements are a financial arrangement that is often used in legal cases to provide a stream of future payments to a plaintiff. While this can be a useful tool for those who have received a settlement, it is not always the best option for everyone. In this article, we will explore some common questions taxpayers have about structured settlements and provide answers to help you better understand this financial arrangement.

What is a structured settlement?

A structured settlement is a financial arrangement that is often used in the settlement of a large lawsuit. In this type of settlement, the payer (usually an insurance company or other organization) agrees to make periodic payments to the payee (usually the individual or group who has won the lawsuit) over an extended period of time, rather than paying out a lump sum all at once.

There are several benefits to choosing a structured settlement. For the payer, it allows them to spread out the financial burden of the settlement over a longer period of time rather than having to come up with a large sum of money all at once. This can be particularly beneficial for organizations that may not have the financial resources to pay out a large lump sum all at once.

For the payee, receiving smaller amounts of money over a longer period of time can make it easier to manage the funds and make budgeting decisions. It can also help to prevent the payee from making impulsive or financially irresponsible decisions with the money, as they will be receiving it in smaller increments over a longer period of time.

Do taxes apply to structured settlements? 

Structured settlements, which are often used to provide ongoing financial support for individuals who have suffered injuries or damages, are generally tax-free. This means that the recipient does not have to pay taxes on the payments received as part of the settlement. The government views structured settlements as compensation for injuries or damages, rather than as income, so they are not subject to taxation.

However, there are some exceptions to this rule. If the structured settlement involves money that would normally be considered taxable income under normal circumstances, such as back pay settlements, divorce payments, punitive damages, lottery winnings, or liquidation, it may be treated as normal income and subject to taxes. In these cases, it is important to consult with a financial advisor or tax professional to determine the appropriate tax treatment of the settlement payments.

Overall, it is important to carefully review the terms of a structured settlement and understand any potential tax implications before accepting the settlement offer. By doing so, you can ensure that you are receiving the full benefits of the settlement and that you are in compliance with all applicable tax laws.

Can you transfer, sell, or pass the settlement down as an inheritance? 

You can transfer, sell, or pass your settlement down as an inheritance, but there are certain steps you need to follow in order to do so legally. The law was changed in 2001 to allow these activities, but there are certain requirements that must be met.

To transfer a settlement to another individual, that person must be listed as a beneficiary and must present a death certificate and identification to the annuity company in order to receive the payout. If the recipient is eligible, the settlement will remain tax-free for them.

If you choose to sell your structured settlement in order to receive the remaining lump sum, this is also allowed. The money you receive from the sale of your settlement is not taxable as long as the original contract remains unchanged.

If you want to give your settlement away, it is important to keep the original terms intact. You won’t be able to get the settlement back once you give it away, so this must be a clear and thoughtful decision. It is always a good idea to consult with a legal professional before making any decisions about transferring, selling, or giving away a settlement.

Are structured settlements and annuities the same thing?

Structured settlements and annuities may appear to be similar on the surface, but they actually operate under different tax laws. A structured settlement is a financial arrangement in which a person receives a series of payments over time, typically as a result of a legal settlement or judgement. These payments are typically designed to cover ongoing expenses or damages, and they are set up by a court in order to avoid any tax liabilities.

Annuities, on the other hand, are financial products that provide a stream of payments over a set period of time, usually in the form of a retirement income. While annuities can be used to set up structured settlements, they can also be used for other purposes, such as saving for retirement or providing a source of income during retirement. If an annuity is not part of a structured settlement, it may be subject to tax liabilities depending on the specific terms of the annuity contract and the laws in the jurisdiction where it is held.

Final Thoughts

Taxpayers have a lot of uncertainty and confusion surrounding structured settlements. It is important for taxpayers to seek professional guidance and advice to fully understand their options and make informed decisions about their financial settlements.

The Certified Public Accountants (CPAs) at Miod & Company are here to help you navigate the complexities of structured settlements. Schedule a free consultation to find out how we can assist you.