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Structured Settlements to Resolve Personal Injury Matters

A popular way to compensate personal injury victims is with “structured settlements” because of their tax-free treatment and ability to provide financial security.

A structured settlement is an agreement made to settle a monetary claim or lawsuit. It provides for a series of payments made over a period of time, rather than in one large, lump sum. The future payments are secured by an insurance company annuity or a U.S. government obligation.

Although structured settlements are generally used to settle personal injury claims, they can also be helpful in resolving other types of monetary claims, such as employment discrimination, wrongful termination, harassment complaints, class actions and environmental litigation.
    Some business purchases and buy-outs can also involve structured settlements. Payments from these non-personal injury cases are not tax-exempt. However, the recipient only owes taxes on the amount of money received each year.

First used in the 1960s to settle a rash of cases resulting from the drug thalidomide, structured settlements became more common after 1982. That’s when the federal government formally recognized and encouraged their use in personal injury cases by passing the Periodic Payment Settlement Tax Act of 1982, which made payments, and any investment earnings from the underlying annuity, tax-free.

Before that time, damages paid in an injury lawsuit often came in the form of a single lump sum. The injury victim, or the family, had to manage the money with little financial experience and there was always the risk that it would run out — leaving the victim without medical care and other support.

In 2002, a law was enacted to protect injury victims who choose to sell payments from a structured settlement to third-party companies. The federal legislation addressed concerns about transactions in which finance companies purchase future structured settlement payments in exchange for a discounted lump sum cash payment.

Unfortunately, victims may not realize that cashing in their structured settlements can result in less financial stability and adverse tax consequences. The following table explains the tax differences:

Personal Injury
Lump-Sum Payment

Personal Injury
Structured Settlement Payments

Tax-free if certain conditions are met. Tax-free if certain conditions are met.
Interest and dividends from investing the lump sum are taxable. Earnings included in annuity payments are tax-free to the recipient.

Under the law passed in 2002, before a company can purchase a structured settlement from an injury victim, a court must first approve the transaction as being in the best interests of the victim. If there is no court approval, a punitive tax penalty will be imposed.