What is a Structured Settlement?

A structured settlement is a method of compensating injury victims, implemented as an alternative to a lump sum payment. It is a voluntary agreement between the claimant (the injury victim) and the defendant, and seeks to offer a degree of income protection for the victim, either for life or for an agreed number of years. Once the parties in a physical injury case have agreed on the long-term costs occasioned by the injury (such an agreement can happen at any time before, during or even after a lawsuit), the defendant then agrees to fund an ongoing income stream to meet these needs.

Lump sum compensations awarded by the courts are, in themselves, tax-free. However, the large sums involved would usually be invested, and the investment income attracts income tax, significantly reducing the lifetime value of the compensation. With a structured settlement, the defendant remains liable for the full compensation awarded by the court. Rather than giving it straight to the plaintiff (or their lawyers), the defendant or property/casualty company purchases an annuity, naming the claimant as the payee (though it is also legally possible to create a trust that is invested solely in United States Treasuries). The claimant owns the right to be the payee, but is NOT the owner of the annuity.

This is an important distinction, since without ownership of the annuity, the claimant is under no tax obligation whatsoever (regarding the regular payments), and receives the full benefit of the settlement. Though there are variations in the defendant’s possible management of the payment protocol (such as transferring the obligation to a third party by means of a legal device, known as a ‘qualified assignment’), the overall result is that the claimant receives a protected, long-term income that is intended to meet future living expenses and medical costs.

In several common law countries, including the United States, structured settlements have become part of the statutory tort law. They are seen as an asset-backed security, and are remarkably flexible in the initial set-up, malleable to practically any set of circumstances or needs. For example, an injury victim could perhaps receive regular monthly payments, yet also have provision made for larger payouts at intervals, to correspond with foreseeable medical and living costs, such as the replacing of an electric wheelchair every five years. It should be noted, however, that once the agreement has been finalised, it is permanently fixed, and the courts do not look kindly on attempts to renegotiate the terms. This is especially true when the structured settlement has been put in place for the protection of a minor child’s future income.

Within the parameters of the Internal Revenue Code Section 5891(c)(1) (26 U.S.C § 5891(c)(1), a structured settlement is defined as an “arrangement”, whereby the following requirements are met:

• A structured settlement must be established by:

- A suit or agreement for periodic payment of damages excludable from gross income under Internal Revenue Code Section 104(a)(2) (26 U.S.C. § 104(a)(2)); or

- An agreement for the periodic payment of compensation under any workers’ compensation law excludable under Internal Revenue Code Section 104(a)(1) (26 U.S.C. § 104(a)(1)); and

- The periodic payments must be of the character described in subparagraphs (A) and (B) of Internal Revenue Code Section 130(c)(2) (26 U.S.C. § 130(c)(2))) and must be payable by a person who:

• Is a party to the suit or agreement or to a workers’ compensation claim; or
• By a person who has assumed the liability for such periodic payments under a qualified assignment in accordance with Internal Revenue Code Section 130 (26 U.S.C. § 130).

Prior to the 1970’s, when Congress began encouraging expanded use of structured settlements, it was often the case that victims in receipt of large awards were placed in the unenviable position of dealing with life-changing physical effects, at the same time as having to deal with the stresses of managing huge sums of money, often for the first time. In these circumstances, it is not surprising that many people found themselves without the resources for a life of medical care.

It is the measured and protective response of structured settlements to the preservation of future security for injury victims, that attracts the endorsement of national disability rights organizations, such as the American Association of People with Disabilities, and the National Organization on Disability.