Internal Revenue Code Section
104(a)(2) provides an exclusion from gross income for payments received on
account of personal physical injury or physical sickness. The payments can be
received as the result of a suit or by agreement between the parties. The
exclusion applies to both one-time payments and payments made over a period of
time.
Internal Revenue Code Section 104(a)(1) excludes from gross income compensation
a person receives for injury or sickness under workers' compensation laws.
The Internal Revenue Service has ruled that a properly designed structured
settlement will flow income tax free to the recipient, providing that certain
guidelines are met. Payments made to an estate after a recipient's death are
also income tax free (Rev. Rul. 79-220). President Reagan signed into law
"The Periodic Payment Settlement Act of 1982", turning the
administrative ruling of the IRS (79-220) into law. Thus, we now have certainty
under law that a properly arranged structured settlement, as paid, is entirely
free from income taxes.
Revenue Ruling 79-313 states that payments increasing in size made over time
were excludable from the recipient's gross income.
Under the current Internal Revenue Code Section 104(a)(2), it does not matter
for purposes of exclusion whether the payments compensate the person for past
and/or future lost income, medical needs, or pain and suffering. No payments
received for these elements of damages need be claimed as income. This is
currently true for personal injury tort cases involving personal physical
injury or physical sickness.
PUNITIVE DAMAGES
The Small Business Job Protection Act of 1996, signed by President Clinton on
August 20, 1996, changed the tax treatment of Punitive Damages. This Bill
codified the "Origin or the Claims Test" which says that any damages,
other than punitive damages, that flow from a physical injury caused by a tort
are income tax free.
CONSTRUCTIVE RECEIPT
Under Private Letter Rulings 8333035 and 9017011, participation in the
development of the pattern of future payments, knowledge of the existence,
cost, or the present value of the future periodic payments does not cause the
claimant/plaintiff to be in constructive receipt of the cash value of the
settlement. Income that is not actually received by the tax payer is
constructively received by him/her if credited to his/her account, set apart
for him/her, or made available so that he/she may draw upon it at any
time.
