by John Darer CLU ChFC MSSC CefT RSP CLTC
“Is a structured settlement annuity taxable? And is the initial amount that I get from the settlement taxable?”, asks a settlement planning firm.
Here is their response:
"If the origin of the claim is based on a personal physical injury, Section 104[a] of the Internal Revenue Code states that the initial principal amount on the settlement that the client receives is not taxable. It is tax-exempt at the state, local, and federal levels. however, if the client decides to invest their settlement funds, then the interest that grows from the investment is taxable. One way to avoid this is to establish a structured settlement annuity for the client to receive their settlement funds. All of the interests (sic) that grow inside of the structured annuity will also be tax-exempt. Payments received from a structured settlement annuity do not need to be reported on any tax return form (1040) or any tax document. Both the principal amount and interests (sic) in the annuity are completely tax exempt".
Here's the thing...
- The Internal Revenue Code is Federal tax code. While there may be state and local tax laws that are modeled after federal tax law, those are the dominion of the individual states or local governments and their respective departments of revenue.
- IRC Section 104 (a)(2) permits a taxpayer to exclude from gross income "the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or physical sickness" Source: Internal Revenue Service irs.gov
- The key take away is that it is the damages that are tax exempt. With a properly established structured settlement, that starts with an obligation to make future periodic payments as damages on account of personal physical injury, where the obligation is generally assigned by way of a qualified assignment, and then funded with a structured settlement annuity or structured settlement annuities as a qualified funding asset, each of the future payments is tax exempt.