Generally, income as a result of personal injury is not taxable, depending on the specific type of award. However, some areas are taxed as income. For this reason, and the fact that there is a certain amount of gray area when settlements are not categorized into specific taxable groups, many settlements are set up in a structured settlement, often as an annuity, to completely avoid paying tax on the award. This is one of the primary advantages to a structured settlement.
However, it becomes a completely different tax beast once the structured settlement is sold. In the last few years, several companies have surfaced offering to purchase structured settlements from individuals wanting to obtain a lump sum of cash in exchange for periodic payments. While the general rule is that awards (that are taxable) are considered as income during the year they are awarded. However, once the
money goes into a structured settlement and is sold, the proceeds may lose the tax-free status. This is even more a concern since new legislation has gone into effect trying to limit the ability to transfer structured settlements.
In 2002, President Bush signed the initial round of legislation to stop settlement funding abuse, in what was then perceived as a shady business. As a result of those laws, as well as proceeding statutes, there are very strict requirements to buying a structured settlement. In fact, many states require court approval before any sale can take place or an additional 40% tax is placed on the proceeds of the sell. The reason for this is supposed to be to protect people from paying high interest rates and selling a structured settlement for considerably less than its real worth. For in-depth tax questions in your state, it is best to contact a local tax advisor.
