When settling non-personal injury cases, income taxes are dreaded by both attorneys and their clients. Structured settlement annuities and market-based structured settlements are creative ways for both parties to mitigate their tax liability and keep more money in their pockets.
Qualified vs. Non-Qualified Settlements
Internal Revenue Code Section 104 allows the taxpayer to exclude compensatory damages from gross income if the settlement resulted from a physical injury claim. Life insurance companies call these qualified settlements because they qualify for income tax exemption. When a qualified settlement is placed into a structured settlement annuity, the interest earned also remains tax-free.
The converse is referred to as a non-qualified settlement. These settlements are subject to income tax. Taxable cases include, but are not limited to, sexual harassment, discrimination, wrongful termination, construction defects, D&O and E&O claims, and more. Attorney contingency fees are always taxable as gross income, no matter what type of case.
Using a Structured Settlement to Defer Tax on a Non-Qualified Settlement
When a client defers receipt of any portion of their settlement, income tax is only due on the amount received in a given tax year. Stretching out the settlement payment over time can accomplish a few things for your client:
- Reduce tax burden
- Potentially lower tax bracket
- Grow tax-deferred (on settlement principal)
- Provide a long-term income source
Law firms and individual attorneys can defer their contingency fees using the same strategy.
Lawyers and their clients can also utilize market-based structured settlements, which allow for greater growth potential and can be actively managed by their own investment advisors. Again, taxes are deferred until the income is received.
Learn More About Structured Settlement Strategies for Taxable Settlements
To learn more about financial options for taxable settlements and attorney contingency fees, contact your Sage consultant today.