When Does Nontaxable Income From A Structured Settlement Become Taxable To An Estate?

by John Darer® CLU ChFC MSSC RSP CLTC

Structured settlements, referring to periodic payments from the classic personal injury version, retain their income tax status when paid to a beneficiary.

Payments under the classic structured settlement are for payment of damages which are of the form excluded under IRC 104(a)(2)  or IRC 104(a)(1) in the case of workers compensation payments.

Don't Worry You Can't Get IRD From Eating a Big Mac, Spicy Indian Food or a Chili Dog

Payments from such structured settlements are generally included in the taxable estate of the decedent.

If the present value of the unreceived payments (that will now be going to the beneficiary) together with other assets that form the decedent estate, exceed an exempt amount* an estate tax is due.

A complete discussion of the estate tax cannot be done justice in a short blog post, but generally the estate tax is due within 9 months of death. Furthermore there are estate or inheritance taxes on both the Federal and State levels. Through careful advance planning there are a number of technioques to mitigate the estate tax problem if it exists. For example, some people can effectively "prepay" the estate tax at a discount using life insurance and gift tax exemptions.

If we are talking structured settlements in the non classic sense, such as employment cases, structured attorney fees and other non qualified structured settlements used in taxable damage cases the same estate tax scenario applies. One must however be cognizant of the Income in Respect of Decedent issue (IRD).

IRD is not some new form of gastric reflux or the nickname for a numerical New York City subway line.  One could say it's a form of "income reflux". Income In Respect of a Decedent is the name given t o 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. IRD retains the same tax nature after death as it would have had if the decedent had received the item of income while alive. There is no step-up in basis for IRD items.

*$5MM on a Federal level. Check the state levels in your state.