Structured Settlement was brought into force through a unique legal arrangement in 1983 wherein settlement between two parties – the claimant who files a lawsuit against the other party, the defendant, for an injury claim or the workers compensation etc., can be settled for the claimant in a structured way of receiving it in installments rather than as a lump sum amount. For instance, a claimant may wish to be given $ 10,000 yearly for first 5 years and $ 15,000 for remaining 10 years (given the total compensation amount is $ 2,00,000). The claimant can also choose to have no payments for few initial years and fixed annual installments thereafter to fund retirement needs.
There are many possible variations in structured settlement, each of which are discussed below:
Qualified Structured Settlements (for physical injury)
Qualified structured settlements are those that qualify for preferential tax treatment of having no tax liability at all. These apply for the cases of personal injury loss such as worker’s compensation or injury in an accident etc. In 1960s, a drug sold widely to treat morning sickness in pregnant ladies, called Thalidomide, caused huge deformities and birth defects in small children. Structured settlement was used to pay off the claims since the drug manufacturer did not have enough money to settle all claims at once in lump sum amount.
There are many occurrences of losses to the workers in a factory or an industry where the worker gets severe physical injuries. The law guarantees right to compensation to these workers. The social security benefits are limited to 80% of the worker’s present income, which may get eliminated if the worker opts for a lump-sum settlement. But, if he opts for a structured settlement, he may continue to receive periodic payments along with the social security benefits in the long run and all of it would be free of taxes.
Generally in cases that are for personal injury or for medical negligence, there is a provision to maintain a Medical trust or a Medical Fund called the Reversionary trust to cater to the unforeseen medical needs. These provisions are in built in the settlement contract so that a specific amount is deposited periodically into the fund. These can be set up with an initial lump sum amount and help tide over financially tough and inflationary times.
The special needs trust help make the claimant eligible for receiving both, the settlement claims as well as social security benefits provided by the government. According to the Omnibus Reconciliation Act of 1993, any amount held in this fund is not considered as the asset of the claimant, thus he becomes eligible for the security benefits provided by the state. But a claimant must be aware of the fact that once these trusts are provided for by law in the settlement contract, they cannot be undone. At the same time they can fund many needs which the social security benefits may not be able to address.
Qualified Settlement Fund
A qualified settlement fund is created under the Internal Revenue Code Section 468B. It is established to fund the entire payments schedule to the claimant by the defendant. The court approves the creation of this fund and appoints an administrator to oversee the whole process. The defendant pays the whole of the compensation amount into the Qualified Settlement Fund and frees himself from the responsibility of any more payments on time to the claimants. The fees for the lawyer or attorney are also released from this fund. After all the payments have been made to the claimants, the Qualified Settlement fund is dissolved.
The structured settlements are becoming popular with the settlement of claims for people who have suffered in injury in an accident or due to medical negligence. Internal Revenue Code Section 104(a) (3) establishes that payment under disability policies as compensation for personal injuries is excluded from gross income. Structured settlements are specifically beneficial in this case because they not only assure that the person receives the benefits of the settlement amount but also receives a continuous flow of non-taxable income to support his needs. These hold true in case the person injured is a child/minor as the settlements are backed by top-rated highly credible insurance companies. These fulfill the need for a stable and guaranteed constant flow of income for some time etc. to fund the educational, medical and other needs of the individual.
The non-qualified structured settlements apply for the cases that do not qualify under the qualified settlements category. These are for cases of non-personal injury loss such as Race Discrimination, divorce, sexual harassment of non-physical origin of claim etc. These non-qualified structured settlements do not qualify under section 130(c) of the Internal Revenue Code that sets specific conditions to be met in order for the liability assignment to retain its "qualified" or tax exempt status. These taxes accrue only on the part of the amount received in a particular year. Moreover, they claimants can save themselves from this liability by paying the tax on entire lump sum immediately if they want to get rid of the risk of fluctuations on interest rates in future.