Sell Structured Settlement Tax Implications 1 — Questions and Answers
Question 1: Are the original structured settlement periodic payments received by a plaintiff for physical injury taxable under US federal law?
- Yes, fully taxable as ordinary income
- No, they are excluded from gross income under IRC Section 104(a)(2) (Correct answer)
- Yes, but only the interest portion is taxable
- Only payments above $10,000 per year are taxable
Correct answer: No, they are excluded from gross income under IRC Section 104(a)(2)
IRC Section 104(a)(2) excludes structured settlement periodic payments arising from physical injury or sickness from the recipient's gross income entirely.
Question 2: When a payee sells their structured settlement payments for a lump sum, is the lump sum received tax-free?
- Yes, always tax-free under IRC Section 104
- No — the IRS has ruled that the lump sum may be taxable income depending on circumstances (Correct answer)
- Yes, because structured settlements are always tax-exempt
- No, it is always taxed as capital gains
Correct answer: No — the IRS has ruled that the lump sum may be taxable income depending on circumstances
The IRS has indicated that a lump sum received from selling structured settlement payment rights may constitute taxable income because the tax exclusion under Section 104 applies to periodic payments, not to proceeds from a sale.
Question 3: Under IRC Section 5891, who bears the 40% excise tax when a structured settlement transfer lacks a qualifying court order?
- The payee selling the payments
- The factoring company (the acquirer) (Correct answer)
- The annuity issuer
- The original defendant
Correct answer: The factoring company (the acquirer)
IRC Section 5891 places the 40% excise tax obligation on the factoring company that acquires the structured settlement payment rights without a qualifying court order.
Question 4: What is a 'qualified assignment' under IRC Section 130, and what is its tax benefit?
- It is the court order approving a transfer — it eliminates capital gains tax
- It allows the defendant to assign periodic payment obligations to a third party on a tax-free basis, with amounts received by the assignee excluded from income (Correct answer)
- It is a payee's election to receive tax-free lump sums
- It is an IRS exemption for factoring company income
Correct answer: It allows the defendant to assign periodic payment obligations to a third party on a tax-free basis, with amounts received by the assignee excluded from income
Under IRC Section 130, a qualified assignment lets the defendant transfer the obligation to make future payments to a third-party assignee without tax consequences to the defendant or assignee.
Question 5: How are punitive damages received through a structured settlement typically treated for federal tax purposes?
- Fully tax-exempt like compensatory personal injury payments
- Taxable as ordinary income because they are not received for physical injury (Correct answer)
- Subject to capital gains tax only
- Tax-free only if received over more than 10 years
Correct answer: Taxable as ordinary income because they are not received for physical injury
Punitive damages are taxable as ordinary income even if structured as periodic payments, because IRC Section 104 only excludes compensatory amounts for physical injury or sickness.
Question 6: What tax reporting form does a factoring company use to report a structured settlement transfer payment to the IRS?
- Form W-2
- Form 1099 (typically 1099-MISC or 1099-OTHER) (Correct answer)
- Form 1065
- Form K-1
Correct answer: Form 1099 (typically 1099-MISC or 1099-OTHER)
Factoring companies typically issue a Form 1099 to report the lump-sum payment made to a payee in a structured settlement transfer, reflecting it as potentially taxable income.
Sell Structured Settlement Tax Implications 1
Are the original structured settlement periodic payments received by a plaintiff for physical injury taxable under US federal law?