by John Darer CLU ChFC MSSC RSP CLTC
"Is there an income tax on inheritance of structured settlement payments?" came the Bing structured settlement question of the day.
The answer is "It depends".
While traditionally the word structured settlement applies to periodic payments for damages used to resolve a claim or lawsuit for personal physical injury or physical sickness, or workers compensation ("qualified structured settlements) , the keyword "structured settlement" in recent years has been applied, right or wrong, to the use of periodic payments for non qualified types of damages and for periodic payments in the secondary structured settlement market.
Let's look at the income taxation of each at death.
A. Qualified structured settlements (primary market)*
Periodic payments for qualified structured settlements are income tax free subject to the exclusions found in the Internal Revenue Code at IRC 104(a)(1) and 104(a)(2). At death the payments retain their income tax free status to the named beneficiary. If the decedent's estate is sufficiently large however, the present value of any inherited payments (which are included in the estate) may result in estate or inheritance taxes taxes.
B. Non qualified structured settlements (primary market)*
Periodic payments for non qualified structured settlements are taxable when received. Thus payments to beneficiaries would also be subject to income tax.
Income In Respect of a Decedent (IRD) is the name given to all types of taxable income earned, but not received by the decedent by the time of his or her death. IRD is NOT taxed on the final return of the decedent, instead, it goes on the return of the person or entity receiving the income. Sometimes this is the surviving spouse, sometimes the estate, sometimes some other beneficiary.
Structured attorney fees and other attorney deferral programs fall into this category regardless of whether they were set up via a qualified assignment or non qualified assignment.
C. Secondary Market Purchased Structured Settlement Payments*
Generally it is believed that payments that flow from structured settlement payment rights purchased in the secondary structured settlement market (factored structured settlement payment streams) are subject to income tax on interest earned over basis.
There are estate planning strategies that can mitigate the effect of income tax and estate taxes on the non qualified cases, where the taxable estate is likely to exceed state and/or federal estate tax exemptions. Please contact this author for more information.
- assuming properly set up