Structured Settlement is the gift of a wonderful legal arrangement in 1983 which makes it an innovation in the financial and insurance arena. Structured Settlement is the special form of compensation amount payable for any form of damage done to a party (like injury by medical negligence) by another party against whom the victim files a lawsuit. The unique feature of this settlement amount is that it consists of one part of the amount paid to the claimant initially and the other part of the larger amount which is paid out to that party through installments instead of paying the whole compensation as a lump sum. These installments can be variable depending on the agreement between the two parties like – a smaller annual amount for next 20 years or a larger amount per year for next 10 years etc. The amount for initial few years could vary from the installment amount for years thereafter. Thus the claimant can also choose to have no payments for few initial years and fixed annual installments thereafter to fund retirement needs. It has also become a popular settlement option in the insurance sector where the insured can claim the insurance money, in a structured way of receiving it in installments rather than as a lump sum amount.
Structured Settlements were first brought to the financial scene as a mode of claims settlement when in 1960s, a drug sold widely to treat morning sickness in pregnant ladies, called Thalidomide, caused huge deformities and birth defects in small children. This was for the first time in Canada that structured settlement was used to pay off the claims of a large number of the affected people since the drug manufacturer did not have enough money to settle all claims at once in lump sum amount.
According to the NSSTA (National Structured Settlement Trade Association), in order to make this form of compensatory mechanism more widespread, the Congress in 1982 laid down specific tax rules called the Periodic Payment Settlement Tax Act and the Section 104 (a) (2) of Internal Revenue Code stated that the whole amount of structured settlement would be tax-free to the claimant.
Over the years following 1982, there have been many amendments in the law of settlements of claims to make it tax-free and flexible regarding payment schedules to suit the needs of the claimant and the capability of the defendant. The very important of those are discussed below:
- Firstly, it is important to note that the whole of the compensation or the settlement amount is free of federal and state income tax. Moreover, the interest payable, dividends and capital gains on the settlement amount are also tax-free. In addition, there is no liability of Alternative Minimum Tax on any amount of structured settlement.
- Beginning the timeline from 1919, earlier the income for personal injury loss was not a part of Internal Revenue Code because prior to 1918, it was not considered as a gain at all. It was only in 1919 that President Wilson signed it into the IRC.
- In a tax ruling of 1922, it was held that the compensation money for the personal damage caused to anyone cannot be considered a part of taxable money in the eyes of law. A major ruling then came about in 1983 wherein, President Ronald Reagan formally signed in structured settlement’s benefits in federal law. The law amended the section 104(a) (2) and stated that the whole of the compensation amount of a structured settlement’s payments are the money for damages which is received by the victim free of any federal tax liability. The IRC Section 130 also made these funded annuity contracts safe, secure and long-term money providing instruments to the victims of personal injury losses.
- In 1996, President Bill Clinton signed the Small Business Job Protection Act clearly stated that any compensation for damages or losses other than the penal damages that were caused due to personal injury caused by a wrongdoing shall be excludable from the victim’s gross income. NSSTA also fought to preserve the treatment of compensation money as tax-free and excludable from gross income in cases of personal injury losses.
- In 1997 Taxpayer Relief Act was legally entitled to resolve Workers Compensation cases through the use of structured settlements. Structured Settlement is a source of a guaranteed income stream with the freedom to spend the money as per the claimant’s desires. Thus structured settlement could provide periodic payments to the victims which guaranteed regular payments stream.
- In 2001, Victims of Terrorism compensation Act was passed under the regime of George Bush. This regulated the necessary laws and guidelines and rules needed by the claimant to transfer or sell off whole or part of the rights to receive future payments on the terms of the structured settlement devised earlier.
The Periodic Payment Settlement Act of 1982, ensures that the claimant receives a guaranteed income stream over the period of settlement agreed upon by the parties. Any such agreement is entered into in the presence of the court of law and has thus, all the legal backing required. Thus, Structured Settlement has evolved over time to provide benefits to all the parties involved.