by: Thomas D. Begley, Jr.

Since The Great Recession, the Federal Reserve has reduced interest rates and kept them low as a means of stimulating the national economy.  Most economists believe that this strategy is effective in achieving its goal.  However, one casualty is the structured settlement industry.  Since 2008, sales of structured settlements have declined by 22%.  The problem is that in purchasing a structured settlement now, the plaintiff is locking in historically low interest rates for a long period of time.  There are a number of other considerations in determining whether or how much of a personal injury settlement to structure.  These include:

  • Lifetime Payment.  A structured settlement can guarantee the plaintiff a lifetime income to cover living expenses.  The amount of the income can be flexible.
  • Creditor Protection.  A structure can guarantee an income stream that is free from the claims of the injured person’s creditors until receipt.
  • Family Members.  A structured settlement can guarantee income to spouses and minor children of the plaintiff.
  • Fiscal Restraint.  The structured settlement makes it more difficult, although not impossible, for the injured plaintiff to squander the money prior to its being received.  The plaintiff still has the right to sell the structured settlement on the open market, but if the structure is combined with the trust, such resale becomes virtually impossible.
  • Rated Age.  If a plaintiff has medical conditions warranting the establishment of a rated age that is higher than the plaintiff’s actual age, the periodic payout from the structure can be considerably higher.  This maximizes the settlement for the lifetime of the plaintiff.  The insurance company assumes the full risk of the plaintiff outliving the rated age.

An often overlooked consideration is the tax implication of purchasing a structured settlement.  While the tax issues are complex, the plaintiff deserves a careful analysis.  Tax factors that must be considered include:

  • Compensation for Physical Injuries or Physical Sickness.  If the settlement is for a claim for physical injuries or physical sickness, the payment to the plaintiff is tax free.[1]  Claims for emotional distress are generally not considered physical injuries and are taxable.  However, if there is a physical injury resulting from the emotional distress, the settlement may be non-taxable.
  • Tax-Free Income Component.  A payment from a structured settlement includes a return of principal. If the underlying claim is for a physical injury, the principal would be tax free.  Each payment also includes a component for income.  Again, if the underlying claim is for a physical injury or physical sickness, the income component of the structured settlement is non-taxable.[2]
  • Medicare Tax of 3.8% on Investment Income.  Beginning January 1, 2013, there is a 3.8% tax imposed on investment income for individual taxpayers with an adjusted gross income in excess of $200,000 per year or married couples with an adjusted gross income in excess of $250,000 per year.  This tax does not apply to income from a structured settlement.  In large personal injury settlements, this can be a significant consideration.  The investment income on a lump sum would be taxed, while the payments from a structured settlement would not be taxed.  A useful strategy might be to structure a portion of the settlement and lump sum the remainder.  Depending on the situation, a 50-50 balance between lump sum and structure is often desirable.
  • Kiddie Tax.  If a plaintiff is under 18 years of age, the Kiddie Tax generally applies to passive income in excess of $2,000 earned by a child who does not file a joint return, has at least one living parent (natural or adoptive), and (1) is under 18, (2) became 18 in the given tax year and earned non-passive income constituting 50% or less of his or her support, or (3) is 19 to 23, earned non-passive income constituting 50% or less of his or her support, and is a full-time student for at least five months of the year.  Under the Kiddie Tax, the child’s income is taxed at the rate of the parents’ income.  If the parents are in a high income tax bracket, the solution may be to purchase a structured settlement to defer the income until years when the Kiddie Tax no longer applies.
  • Alternative Minimum Tax (AMT).  Legal fees of plaintiffs are often subject to limitations applicable to miscellaneous itemized deductions.  Miscellaneous itemized deductions are disallowed in computing a taxpayer’s AMT liability.  Therefore, if a plaintiff in a personal injury action, not resulting in physical injury or physical sickness, receives a large taxable lump sum award, the plaintiff may be unable to offset the taxable income by deducting legal fees.  By structuring the settlement, the taxable proceeds can be received over many years reducing the plaintiff’s taxable income in each year, thereby avoiding the effect of the AMT.
  • Emotional Distress Damages.  If a plaintiff receives a settlement for emotional distress that is taxable, he or she can subtract from damages any medical expense incurred as a result of the emotional distress being compensated, so long as the expenses were not previously deducted.[3]  It is clear that this exception applies to payment for past medical care.  It is less clear that future damages paid for an emotional distress claim can be excluded.  The solution is to postpone for tax purposes the receipt of compensation until the matching medical care expenses have been incurred.  The device for achieving this result is a structured settlement.  If the plaintiff is to receive $200,000 for an emotional distress claim in a lump sum, tax would have to be paid at that time.  If instead the plaintiff elects to purchase a structured settlement paying $10,000 a year for 20 years and that $10,000 matches each year’s medical care expense of $10,000, it can all be excluded from gross income saving the client thousands of dollars.  Such a strategy was approved by the Internal Revenue Service.[4]


[1] I.R.C. §104(a)(2).

[2] Rev. Rul. 79-220.

[3] I.R.C. §104(a).

[4] P.L.R. 2008-36-019.