IRS Ruling 79-220: Is Your Structured Settlement Tax-Free?

Revenue Ruling 79-220 provides critical guidance on the tax treatment of structured settlements. The ruling clarifies that the full amount of periodic payments received under a structured settlement is excludable from gross income under Section 104(a)(2) of the Internal Revenue Code. This means that the recipient does not have to pay taxes on these payments, which can be a significant financial benefit. The ruling also specifies that payments made to the estate after the recipient's death are fully excludable from gross income. This ensures that the financial benefits of the structured settlement continue to support the claimant's beneficiaries.

Five Significant Recommendations for Handling Structured Settlements Following Ruling 79-220

  1. Document the Settlement Terms Clearly: Ensure that the terms of the structured settlement are clearly documented, including the payment schedule, amounts, and any contingencies. This documentation should be readily available for examination to avoid any disputes or misunderstandings in the future. Generally, pain and suffering damages enjoy the strongest protections against taxation, and so settlement terms that allocate accordingly are generally preferred.

  2. Consult with Financial and Legal Advisors: Engage financial and legal advisors who are experienced in structured settlements. They can provide valuable guidance on structuring the settlement to maximize tax benefits and ensure long-term financial stability. However, some advisors only handle annuities in general and may not be familiar with the intersection of the legal claims process and structured settlements.

  3. Consider Future Financial Needs: When negotiating the terms of the structured settlement, consider the claimant's future financial needs, including medical expenses, living costs, and any other long-term obligations. Tailor the payment schedule to meet these needs effectively. Make sure that it is clear that the structured settlement is fashioning these terms as compensation for an injury (i.e. not punitive damages).

  4. Evaluate the Credibility of the Annuity Provider: Choose a reputable and financially stable annuity provider to fund the structured settlement. The financial strength of the provider is crucial to ensure that the claimant receives the agreed-upon payments without risk of default. This is especially important if the payouts last more than 10 years, but less of a concern if the payments are fully insured and/or backed by a state guaranty.

  5. Review Tax Implications: Understand the tax implications of the structured settlement, including any potential changes in tax laws that could affect the tax-exempt status of the payments. Stay informed about any updates to the Internal Revenue Code that may impact the settlement.

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