Structured Settlements Tax Treatment and Benefits of Structured Settlements 1 — Questions and Answers
Question 1: Which Internal Revenue Code section excludes structured settlement periodic payments for physical personal injury from gross income?
- IRC Section 72
- IRC Section 104(a)(2) (Correct answer)
- IRC Section 130
- IRC Section 5891
Correct answer: IRC Section 104(a)(2)
IRC Section 104(a)(2) specifically excludes damages received on account of personal physical injuries or physical sickness, including structured settlement payments, from gross income.
Question 2: The Periodic Payment Settlement Act of 1982 was significant because it:
- Imposed a cap of $1 million on tax-free structured settlements
- Formally established the tax-free treatment of periodic payments in personal injury settlements (Correct answer)
- Required all personal injury settlements to be structured
- Created the IRC Section 5891 excise tax
Correct answer: Formally established the tax-free treatment of periodic payments in personal injury settlements
The Periodic Payment Settlement Act of 1982 codified the tax-free treatment of structured settlement periodic payments and encouraged their use in personal injury and wrongful death cases.
Question 3: Under IRC Section 130, a qualified assignment allows the original obligor (defendant) to transfer settlement payment obligations to an assignment company. The assignment company receives:
- A tax credit equal to the present value of payments
- A federal subsidy for each payment made
- An income exclusion for amounts received to fund the assigned obligation (Correct answer)
- A deduction equal to the full face value of future payments
Correct answer: An income exclusion for amounts received to fund the assigned obligation
IRC Section 130 allows the assignment company to exclude from income the amounts received from the defendant to fund the qualified assignment, making the transaction economically viable.
Question 4: Which type of damages in a structured settlement are generally NOT excluded from the claimant's taxable income?
- Compensatory damages for physical injury
- Medical expense reimbursements related to physical injury
- Punitive damages (Correct answer)
- Lost wages arising from a physical injury
Correct answer: Punitive damages
Punitive damages are included in gross income under IRC Section 104, even when arising from a physical injury case, because they are intended to punish the defendant rather than compensate the claimant.
Question 5: The 'constructive receipt' doctrine is relevant to structured settlements because it:
- Determines which state law governs the settlement
- Would cause payments to be taxable if the claimant had the right to demand a lump sum at any time (Correct answer)
- Requires the defendant to fund the annuity before signing the settlement agreement
- Sets the interest rate used to discount future payments
Correct answer: Would cause payments to be taxable if the claimant had the right to demand a lump sum at any time
If a claimant could demand immediate receipt of funds, constructive receipt would make those funds taxable; structured settlements are carefully designed so the claimant never has control over the funds.
Question 6: A structured settlement for emotional distress claims with no underlying physical injury would result in:
- Fully tax-free periodic payments under IRC 104(a)(2)
- Fully taxable periodic payments as ordinary income (Correct answer)
- Capital gains treatment on the growth portion only
- A 50% exclusion under IRS Notice 95-45
Correct answer: Fully taxable periodic payments as ordinary income
Without an underlying physical injury or physical sickness, emotional distress damages do not qualify for the IRC Section 104(a)(2) exclusion and are taxable as ordinary income.
Question 7: Which federal law, enacted in 1982, specifically encouraged the use of structured settlements by codifying their tax-advantaged status?
- The Tax Reform Act of 1986
- The Periodic Payment Settlement Act of 1982 (Correct answer)
- The Employee Retirement Income Security Act of 1974
- The Structured Settlement Protection Act of 2002
Correct answer: The Periodic Payment Settlement Act of 1982
The Periodic Payment Settlement Act of 1982 amended the Internal Revenue Code to clarify that structured settlement payments for personal injury are tax-free and authorized qualified assignments under IRC Section 130.
Structured Settlements Tax Treatment and Benefits of Structured Settlements 1
Which Internal Revenue Code section excludes structured settlement periodic payments for physical personal injury from gross income?