Structured Settlements 4Real® Blog: Structured Settlements | Settlement Planning News and John Darer Reviews

Are Structured Settlements Subject to Federal Estate Tax?

by John Darer® CLU ChFC MSSC RSP CLTC

One often reads the advertising claims that structured settlement payments are "tax free". Such statements are misleading.

The TRUTH

1. To the extent a structured settlement payment represents payment of damages for personal physical injury or physical sickness, or payment for a worker sompensation claim, they are received by  the tax payer INCOME tax free. The relevant sections of the Internal Revenue Code are IRC 104(a)(1) and 104(a)(2)

2. Technically an estate is subject to tax, not a structured settlement.

3. At the death of the annuitant IF, and only if, there are any guaranteed certain payments remaining to be paid in the future, the present value of such payments is included in the decedent's estate along with other items such as the value of bank accounts, stocks etc. On a very basic level, if the total of such items exceeds the exempt amount then an estate tax would be due.  Exemptions apply on both a state and federal level.

4. There are techniques available to reduce or mitigate estate tax.

For more information about estate planning and your settlement,  please contact structured settlement expert John Darer at  888-325-8640

 

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.

Is There A Tax on Structured Settlement Payments at Death?

by John Darer CLU ChFC MSSC RSP CLTC

 Is there an income tax on inheritance of structured settlement payments? 

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

House Passes Estate Tax Reform Bill and It's Good News!

The House passed H.R. 4154, which would:

1. permanently freeze the estate tax exemption at $3.5 million,
   
2. the estate tax rate at 45%, and
   
3. preserve the step up in basis
   

The bill passed by a vote of 225-200, with no Republicans voting for it and 26 Democrats opposed.  H.R. 4154 moved with statutory PAYGO however, exempted from the PAYGO requirement is an extension of 2009 rates for the estate tax (what was passed).  

Statutory Pay  As You Go Act of 2009  ("PAYGO")

Note: While structured settlement payments are income tax free, the present value of any structured settlement period certain or guaranteed lump sum payments remaining and due after an annuitant's death is included in the decedent's estate for purposes of calculating estate tax.