Question
In 1999 I was injured at work. Two years later I received a settlement in which consisted; a $20,000 lump sum payment and a 40-year structured annuity. My lawyer said that I would never have to pay taxes if it was set up that way. Recently I was looking over the contract that we had made, and noticed that it says; as far as he knows, "annuities" are tax-exempt.
My question now is; do I need to file taxes on a structured settlement?
Answer
Internal Revenue Code Section 104(a)(2) provides an exclusion from gross income for payments received on account of personal physical injury or physical sickness. The payments can be received as the result of a suit or by agreement between the parties. The exclusion applies to both one-time payments and payments made over a period of time.
Internal Revenue Code Section 104(a)(1) excludes from gross income compensation a person receives for injury or sickness under workers' compensation laws.
The Internal Revenue Service has ruled that a properly designed structured settlement will flow income tax free to the recipient, providing that certain guidelines are met. Payments made to an estate after a recipient's death are also income tax free (Rev. Rul. 79-220). President Reagan signed into law "The Periodic Payment Settlement Act of 1982", turning the administrative ruling of the IRS (79-220) into law. Thus, we now have certainty under law that a properly arranged structured settlement, as paid, is entirely free from income taxes.
Revenue Ruling 79-313 states that payments increasing in size made over time were excludable from the recipient's gross income.
Under the current Internal Revenue Code Section 104(a)(2), it does not matter for purposes of exclusion whether the payments compensate the person for past and/or future lost income, medical needs, or pain and suffering. No payments received for these elements of damages need be claimed as income. This is currently true for personal injury tort cases involving personal physical injury or physical sickness.
PUNITIVE DAMAGES
The Small Business Job Protection Act of 1996, signed by President Clinton on August 20, 1996, changed the tax treatment of Punitive Damages. This Bill codified the "Origin or the Claims Test" which says that any damages, other than punitive damages, that flow from a physical injury caused by a tort are income tax free.
