Sell Structured Settlement Tax Implications 2 — Questions and Answers
Question 1: A structured settlement designed to compensate for lost wages — rather than physical injury — is treated how for federal income tax?
- Tax-exempt under Section 104
- Taxable as ordinary income because lost wages are not excludible under Section 104(a)(2) (Correct answer)
- Subject to Social Security tax only
- Tax-deferred until payments begin
Correct answer: Taxable as ordinary income because lost wages are not excludible under Section 104(a)(2)
Section 104(a)(2) only excludes damages received on account of physical injury or sickness — payments representing lost wages without a physical injury component are taxable.
Question 2: If a payee sells structured settlement payments at a gain relative to the tax basis, what type of tax may apply?
- Estate tax
- Capital gains tax (Correct answer)
- Excise tax under Section 5891
- Employment tax
Correct answer: Capital gains tax
If the IRS treats the sale of structured settlement payment rights as a capital asset transaction, any gain over the tax basis may be subject to capital gains tax.
Question 3: What is the tax basis of a structured settlement payee's payment rights for purposes of calculating gain on a sale?
- Zero, because the payments were received tax-free (Correct answer)
- The total present value of all future payments at the time of sale
- The original settlement amount paid by the defendant
- The annuity purchase price paid by the defendant's insurer
Correct answer: Zero, because the payments were received tax-free
Because the periodic payments are received tax-free under Section 104, the payee's tax basis in the payment rights is generally zero, meaning the entire lump sum from a sale may be a taxable gain.
Question 4: Does the sale of a structured settlement for a lump sum affect the payee's eligibility for means-tested government benefits such as Medicaid?
- No, settlement proceeds are always exempt from Medicaid asset tests
- Yes — receiving a large lump sum can disqualify a payee from Medicaid or SSI due to asset limits (Correct answer)
- Only if the lump sum exceeds $1 million
- No — federal law prohibits considering settlement proceeds as assets
Correct answer: Yes — receiving a large lump sum can disqualify a payee from Medicaid or SSI due to asset limits
A large lump sum from selling structured settlement payments can push a payee over asset thresholds for Medicaid, SSI, and other means-tested programs, potentially causing loss of benefits.
Question 5: Which professional is best qualified to advise a structured settlement payee on the potential tax consequences of selling their payments?
- The factoring company's sales representative
- A licensed tax attorney or CPA familiar with structured settlement transactions (Correct answer)
- The annuity issuer's customer service department
- The court clerk
Correct answer: A licensed tax attorney or CPA familiar with structured settlement transactions
A tax attorney or CPA with structured settlement experience can analyze the payee's specific situation and provide accurate advice on taxability, basis, and benefits implications.
Question 6: What is a 'structured settlement annuity qualified assignment' company (QAC)?
- A company that buys structured settlement payment rights on the secondary market
- A special-purpose entity that assumes the periodic payment obligation from the defendant under a qualified assignment (Correct answer)
- An IRS-registered clearinghouse for structured settlements
- A nonprofit that provides legal services to structured settlement payees
Correct answer: A special-purpose entity that assumes the periodic payment obligation from the defendant under a qualified assignment
A QAC is typically a subsidiary of a life insurance company that accepts the assignment of periodic payment obligations from defendants, allowing them to fund them with annuities under IRC Section 130.
Sell Structured Settlement Tax Implications 2
A structured settlement designed to compensate for lost wages — rather than physical injury — is treated how for federal income tax?