In the Periodic Payment Settlement Act of 1982 (Public Law No. 97-473), Congress adopted specific tax rules to encourage the use of structured settlements in physical injury cases. This act amended IRC §104(a)(2) so that it would exclude, in addition to the previously excluded lump sums, “periodic payments” derived from personal physical injury or illness from the gross taxable income of award recipients.
Section §104(a)(2) of the Internal Revenue Code clarifies that the full amount of the structured settlement payments is tax-free to the annuitant (by contrast, the investment earnings on an all-cash, lump-sum settlement payment are usually fully taxable).
(a) In General, except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical expenses, etc.) for any prior taxable year, gross income does not include –
(1) Amounts received under workmen’s compensation acts as compensation for personal injuries or sickness.
(2) 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 physical injuries or physical sickness.
Section §130(c) of the Internal Revenue Code allows defendants to transfer funds and assign liability for future payments to a third party who is not required to include the funds in gross income. To establish a qualified assignment, the following requirements must first be met:
- The injury, made basis for the cause of action, must be physical injury.
- Both the injury victim (and his or her attorney) and the defendant and their insurer agree that the periodic payment schedule cannot be accelerated, deferred, increased, or decreased.
- The payment stream may be excluded from the annuity recipient’s gross income for tax purposes.
- A highly secure funding asset (such as an annuity or U.S. government obligation) must be used to fund payments.
- The Annuity Issuer and its Assignee assume the liability from the defendants and/or its Insurer, to make periodic payments to the plaintiff.
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